Using a fixed stop loss is one way traders try to control their potential losses for a given trade. The other way to do that is position sizing – the decision of how large or small a position is taken. Trading forex market at a higher time frames will require that a forex trader set a greater stop loss level.
However a greater stop loss level will mean that the trader take on a greater amount of risk. With proper position sizing, the forex trader will be able to trade on higher time frame like he used to do in smaller time frames.
Position sizing helps a trader to limit the amount of losses made in trading. It forms part of an investment strategy which helps the trader decide how much contract size to enter in each trade.
Use of this forex investment concept is what differentiates the professional forex traders from average traders. This article will explain position sizing in simple terms, the benefits and the ways in which to incorporate into your forex trading.
Getting the right position size to enter a trade is not as complicated as you would imagine. You will first need to decide how much money as a percentage of the account you are willing to lose on a single trade.
The amount varies for every trader, depending on the amount of risk the trader is willing to take on, but generally speaking, 2 to 5 percent is a typical number. The more money you risk on each trade, the faster your account will be damaged if you lose more than one trade consecutively.
Second, you will need to calculate how many pips is your stop loss away from your presumed entry price. Using the following position sizing formula which only applies for the forex market):
(Account balance X Acceptable risk per trade%) / (Number of Pips stop loss away from presumed entry price) = (value denominated in mini lot)
($ 20,000 X 3%) / (75) = 8 mini lots
Using this calculation, we have determined the proper position size for this trade to be eight mini lots. It is important to note the leverage ratio and the margin required for trading 8 mini lots.
Position sizing to keep risk around 2 percent per trade may work well with a $ 25,000 account, but what if you only have $ 1,000 is only $ 20, it does not leave you much risk capital to work with. With micro accounts, a $ 20 risk will typically fit your position into a 100 pip stop loss, which is sufficient for almost any trade.
The problem with micro accounts is that your gains will be less than exciting. The reality is trading require money, it will take small money to make small returns and big money to make big returns. Without proper money management, a trader is doomed for failure regardless of how much is his trading capital.
The rule is to take proper money risk money management by controlling risk with position sizing. Practice and keep practicing. Think in terms of percentage you made and not on the dollar terms you made. Investors think in percentage while employees think in monetary terms. Be an investor, think percentage and forex will be a market you can extract profits in the long term.
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