Lesson 1: Everything You Must Know About Position Sizing

Another way to effectively manage your risk exposure is by controlling the sizes of your trade positions. This practice is called position sizing. 

You've probably read this term used several times already in the previous lessons. That's because position sizing is an essential part of risk management in trading. 

In this lesson, you'll learn more about this concept and how to calculate your trades' position size. 

Lesson Highlights 

• Position sizing is a vital part of trading risk management strategies. 
• Position sizing involves calculating the appropriate number of units you need per trade to keep your risk exposure at a level you're comfortable with. 
• There are two ways to compute position sizes. 
• You need to know five things when calculating position size: account equity, currency pair, risk percentage, stop-loss, and exchange rate. 

What Is Position Sizing?

Position sizing is among the most important skills you can learn when trading forex or any other financial instrument. 

It refers to controlling just the right amount of assets in a trade or buying or selling the correct number of units in a particular currency pair. 

As a forex trader, you are, first and foremost, a risk manager. Keeping your trades' risk exposure at a minimum should be your top priority. 

There are various factors you must consider when it comes to minimizing trading risks. These determinants include: 

• The currency pairs you're trading (e.g., EUR/USD, USD/JPY, etc.) 
• Your trading account's base currency (i.e., the currency you're using to transact) 

How to Calculate Position Size

There are two ways to calculate your trades' position size. 

One method is used for calculating your position size if your trading account's base currency is the same as the counter currency of the pair you're trading. 

The other is for when your trading account is denominated in the same currency as the base currency of the pair you're trading. 

There are other information you should know beforehand when computing position size. These are: 

1. Your account equity or balance
2. The currency pair you're trading 
3. How much of your account (in percentage) you want to risk 
4. Stop-loss in pips 
5. Conversion currency pair exchange rates 

Once you have these components figured out, you can begin determining the size of your trade positions. 

Calculating Position Size If Your Account Denomination Is the Same as the Counter Currency 

Suppose you have a newly opened trading account with a USD $5,000.00 balance, and you want to open a 1-mini lot position in the EUR/USD pair, which is currently trading at 1.5000. 

You're not comfortable with taking big risks, so you want to keep the risk to your account at only 1% and accept a maximum loss of only 200 pips per trade. 

Going back to the earlier section, you'll need the following data for the computation: 

• Account balance/equity: $5,000.00 
• Currency pair: EUR/USD 
• Account percentage risk: 1% 
• Stop-loss in pips: 200 pips 
• Exchange rate: 1.5000 

Now, let's calculate your position size. 

Determine the amount in dollars that you want to risk. To do this, multiply your account equity by the percentage amount you want to risk. 

USD 5,000 * 1% (or 0.01) = USD 50 

Divide the amount risked by the stop-loss to determine the value per pip. 

(USD 50) / (200 pips) = USD 0.25/pip 

Multiply the value per pip by a known pip value ratio of the pair you're trading, in this case, the EUR/USD. With a 1-mini lot position (10,000 units), each pip movement equals USD 1. 

USD 0.25/pip * [(10,000 units EUR/USD) / (USD 1/pip)] = 2,500 units of EUR/USD 

Using this calculation, you can see that you need to maintain a maximum of 2,500 EUR/USD units to stay within your acceptable risk level. 

Calculating Position Size If Your Account Denomination Is the Same as the Base Currency 

Now, let's try determining your position size if your trading account has the same denomination as the base currency of the pair you're trading. 

Using the previous example, let's figure out what your position size would be if you had a EUR-funded account instead of a USD one. 

• Account balance/equity: EUR 5,000.00 
• Currency pair: EUR/USD 
• Account percentage risk: 1% 
• Stop-loss in pips: 200 pips 
• Exchange rate: 1.5000 

You'll follow almost the same process you used earlier but with additional steps. Because your trading account has a different base currency than the EUR/USD pair, you'll have to convert it to USD first, as currency pairs are calculated using the quoted currency. 

Determine the amount in euros that you want to risk. 

EUR 5,000 * 1% (or 0.01) = EUR 50 

Convert this value to USD using the current exchange rate (1.5000). To do this, simply invert the EUR/USD exchange rate and multiply by how many euro units you're willing to risk. 

(USD 1.5000 / EUR 1.0000) * EUR 50 = USD 75 

Divide the amount you got (USD 75) by your stop-loss in pips. 

(USD 75) / (200 pips) = USD 0.375 per pip movement 

Multiply the resulting value (0.375) by the known unit-to-pip ratio. 

(USD 0.375 per pip) * [(10,000 units of EUR/USD) / (USD 1 per pip)] = 3,750 units of EUR/USD 

By following this computation, you'll see that you need to keep your position no larger than 3,750 units to keep your risk at EUR 50 or lower on a 200-pip stop. 

In the next lesson, you’ll learn about one of the five components for determining position size that you’ve read here: stop-loss.