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Especially for trading beginners in Forex trading, but also for advanced traders, one can often observe that these problems have to choose the correct position size for each trade. This is a big problem, because the right position size is an important part of good money management in Forex trading and in the long run it should ensure that your gains from trading at the end of the day are greater than your losses.
How to choose the right position size when trading?
As so often in Forex trading, or even when trading CFDs or other financial instruments, it is not possible to say in general how large the positions should always be. This depends on a number of factors.
Factors on which the position size depends:
- Trading Strategy
- Account balance
- Psyche of the trade
Since every trader is different and follows a different Forex trading strategy, it is crucial to find the position size that best fits your own factors. What happens if the position size does not fit your needs and is too big or too small, we will explain now.
Too high position sizes
If your positions are too large, you will most likely not be able to compensate for a longer series of losses and will probably suffer a total loss in the long run. In addition, emotions such as greed or fear often come into play when trading larger positions, which can prevent you from consistently following your pre-determined trading strategy.
Position sizes too small
If your position is too small, you will in all probability be spared from excessive losses, but your portfolio will not really be able to develop further. This can lead to you not following trading with the necessary seriousness and therefore you may become careless in following your strategy.
Optimal position size
The optimal position size fulfils 3 things. It fits your psyche and also takes into account your account balance and trading strategy. The positions must be small enough that you can continue trading relaxed even after a series of several loss trades in a row and large enough that you are exposed to a reasonable level of stress and consistently follow your trading strategy.
By stress, we mean positive stress that allows you to work in a concentrated manner and increases your sense of responsibility. It does not mean emotional highs and lows that make you doubt your decisions and throw your strategy overboard. This usually occurs when the positions are too big.
Basic rule for correct position sizes
A basic rule when determining the size of positions in Forex trading, but also when trading in all other markets, is
The higher the position size, the tighter you have to set your stop loss. Conversely, the further the stop loss should be from the entry price, the smaller the position size must be.
Another basic rule is that you should never risk more than 1% to 2% of your capital per position taken. Depending on your trading strategy, the maximum risk may also be 4%. However, these are mostly trading strategies in longer time windows. However, the maximum risk of an individual position should never exceed this limit and should always be limited by a stop loss.
We now assume a day trading strategy and a maximum risk of 2% per trade. For example, if you have 10,000 Euros in your account, your risk per position taken should never exceed 200 Euros (2% of 10,000 Euros).
This means that you must choose your position size in such a way that if your position is stopped by your Forex broker, you can lose a maximum of 200 Euros. For example, if you want to trade 1 lot in EUR/USD, the pip value is 10 USD per lot. We will simply assume a price of 1.25, which means that 1 pip corresponds to a profit/loss of 8 Euros.
Maximum stop loss intervals with 10,000 euros capital and 1 lot position size with a maximum of 2% risk per trade
|Position size||maximum stop-loss distance|
|1 Lot||25 Pips Distance to the entry price|
|0.5 Lot||50 Pips Distance to the entry price|
|0.2 Lot||125 Pips Distance to the entry price|
|0.1 Lot||250 Pips Distance to the entry price|
You can place your Stop Loss on a lot at a maximum of 25 pips from the entry price (200 Euro maximum risk divided by 8 Euro profit/loss per pip). If your strategy or trading setup requires another stop loss, you simply need to adjust your position size accordingly to avoid taking too much risk in this trade.
It is not as difficult as some people think to adjust the position sizes correctly. Nevertheless, especially trading beginners often make crucial mistakes. Follow our tips when determining the position size and you can then concentrate fully on your trading.
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