Position Sizing and Risk Management
Position sizing is the setting of the correct amount of units to buy or sell a currency pair. Appropriate sizing of positions and risk management is the main key differentiator between amateur and professional traders in the forex market.
How to calculate Position Size
In order to calculate position size, a number of information must be determined. Firstly, your account equity or balance, the currency pair traded, the percentage of the account you wish to risk, the stop-loss in pips, and conversion currency pair exchange rates.
With that data noted, the traditional calculations can be done. For example:
In this scenario, a trader has deposited $5,000 into his trading account employing a swing trading system that trades EUR/USD and risks for 200 pips per trade. Let’s say the trader has chosen not to risk more than 1% of his account per trade.
Using his account balance and the amount he will risk, the dollar amount to be risked can be calculated as so:
$5,000 x 1% (or 0.01) = $50
Then, divide the amount risked by the stop to find the value per pip.
($50) / (200 pips) = $0.25/pip
Lastly, the value per pip is multiplied by a known unit/pip value ratio of EUR/USD. In this scenario, with 10,000 units (or one mini lot), each pip move will be worth USD 1.
This would summarize the calculation as follows:
USD 0.25 per pip * [(10k units of EUR/USD)/(USD 1 per pip)] = 2,500 units of EUR/USD
With this, you can conclude that in order to stay within the risk comfort level with the current setup, the trader should put 2,500 units of EUR/USD or less.
This is a basic example and there are a lot more advanced calculations to find online pertaining to position sizes in different forex pairs and account currencies.
Of course, doing all this by hand in an active trading environment can be an arduous task. Luckily, there exists a position size calculator that can help you control your maximum risk per position by finding the approximate amount of currency units to buy or sell on the forex market.