When you trade
the FOREX, you
are trading on
margin which
means that you
only need to put
up a fraction
of the amount of
currency you plan to trade.

Choosing your position size correctly is one of the most important factors
in successful trading and is often the core reason why many traders fail.

The problem usually has to do with over trading, or simply put, trading
with position sizes that are too large for the user’s account.

When determining the position size for a trade you should always base it
on the percentage of your account that you are willing to risk on that
trade. As a general rule you do not usually want to risk more than about
5% on a single trade.

When trading, the risk per trade you are taking depends on two factors:-

Position Size
Stop Loss

Your position size is basically how much of a currency you buy (or sell)
and is measured in lots. Your stop loss (SL) is how far you are willing
to let the trade go against you before your exit and take a loss.

Stop loss is measured in pips.

You should never enter a trade if you do not have an exit strategy should it
go against you. You should always know your stop loss value before you
determine your position size and before you enter a trade. 

 To calculate your position size so that that it equates to a percentage of
your account that you are prepared to risk, follow this 2 step process:-

Determine your stop loss in number of pips

Determine the value of 1 pip of the currency pair to be traded

Position Size = (%Risk X Free_Margin) / ((PIP_Value X Stop_Loss))

If you do not have any other trades open, then your free margin will simply
be your entire account balance

Assume you have an account balance of $5000 USD. We want to know how many
lots we should trade of EUR/GBP so that we are only risking 5% of our account.

Let us further assume that you decide to set your stop loss at 112 pips.

Account_Balance: $5,000 USD

PIP_Value: $14.84 USD
Stop_Loss (SL): 112 Pips
%Risk: 5%

Position Size = (%Risk X Free_Margin) / ((PIP_Value X Stop_Loss))

Position Size = (0.05 X $5,000) / ($14.84 X 112)
Position Size = $250 / $1,662.08
Position Size = 0.15 lots

So if the trade moves in your favor by 1 PIP, you will profit by $14.84 USD
for every lot you trade. If the trade moves against you, you will lose
$14.84 USD for every lot you trade.

The maximum adverse movement that you will accept in this example is
112 Pips, as defined by our stop loss.

If for every lot you trade, 1 Pip movement is worth $14.84 USD, then  a
112 Pips movement will cost you $1,662.08 which is 33% your $5,000 account
balance. This is clearly an unacceptable risk and indicates that for your
chosen stop loss a position size of 1 lot is too large.

However, the above formula determine the position size you should trade,
whilst risking only 5% of your account with a Stop Loss of 112 Pips, was
0.15 lots.

Now using this value and the trade moves against you, you will lose only
5% of your account.

Minimizing Losses is Trading Priority number 1.

Number 1 Culprit for Losses is Bad Position Sizing.

Consider this simple question. Suppose you have $1,000 to trade, how much of
this would you spend on your next trade?

Here are some common answers.

Half because if I lose, I still have the other half to trade.

25% because I can handle 4 loses and still recover.

Most people are aware of the compounding effect of money, but new traders
often overlook the fact that their losses compound as well and is very
important for you to remember.

Losses Compound Too!

As an example, say you put the whole $1000 on one trade and lose 50%.

Now, because you only have $500 left, you need your next trade to return
100% just to recoup your previous loss. So, every 50% loss requires a
subsequent 100% win to recover.

If you were to experience two consecutive 50% losses, you would then require
a 400% return to recover! This is a very important concept to always remember

A Loss Always Requires a Bigger Win to Recover.

This is the number one factor that you need to understand in order to become
a successful trader. You should now begin to comprehend the importance of not
over-trading as well as ensuring that your position sizes are only an acceptable
percentage of your account balance.

Is Forex Trading a Losing Battle?

With losses always require bigger wins to recoup your balance, trading appears
to be a losing battle. It is if you have a gambling mindset, but not if you adopt
a more professional approach such as ensuring your trading system has a
positive expectancy value.

If you think trading small will take you a long time to amass serious cash,
just remember, that using the techniques shown in this series of Hubs, you will
be able to compound your profits very quickly.

The key to winning is the preservation of your bankroll. Without it you cannot
play anymore.

Please be advised that Foreign Currency trading involves
substantial risk of monetary loss.

All information contained on this website is provided as general
commentary and must not be constituted as investment advice.

I will not accept liability for any loss or damage, including
without limitation to, any loss of profit, which may arise directly
or indirectly from use of or reliance on this information.

Good Luck with your Forex Trading.

If you have any queries, please leave a comment and
I will do my best to answer it.

Regards,

Terry Allen