Position Sizing & Money Management

An important aspect of forex trading success is taking the correct position size on each trade. A trader position size or trade size is considered more important than your entry or exit point especially in forex day trading. You might have the best trading strategy but if you do not have proper trade size, you will end up facing risks. Finding the proper position size will keep you within your risk comfort level is relatively safe.

In forex trading, your position size is how many lots (mini, micro or standard) you take on your trade.

We can divide the risk into two parts −

  • trade risk
  • account risk

Determining your Position Size

Follow these steps to get the ideal position size, irrespective of the market conditions −

Step 1: Fix your account risk limit per trade

Set aside the percentage amount of your account you are willing to risk on each trade. Many professionals and big traders choose to risk 1% or less of their total account on each trade. This is as per their risk taking capacity (here they can deal with 1% loss & the other 99% amount still remains).

Risking 1% or less is ideal but if your risk capacity is higher and you have a proven track record, risking 2% is also manageable. Higher than that of 2% is not recommended.

For example, on a 1,00,000 INR trading account, risk no more than 1000 INR (1% of account) on single trade. This is your trade risk and is controlled by the use of a stop loss.

Step 2: Determine pip risk on each trade

Once your trade risk is set, establishing a stop loss is your next step for this particular trade. It is the distance in pips between your stop loss order and your entry price. This is how many pips you have at risk. Based on volatility or strategy, each trade is different.

Sometimes we set 5 pips of risk on our trade and sometimes we set 15 pips of risk. Let us assume you have 1,00,000 INR account and a risk limit of 1,000 INR on each trade (1% of account). You buy the USD/INR at 66.5000 and place a stop loss at 66.2500. The risk on this trade is 50 pips.

Step 3: Determining your forex position size

You can determine your ideal position size with this formula −

Pips at Risk * Pip Value * Lots traded = INR at Risk

It is possible to trade in different lot sizes in forex trading. A 1000 lot (called micro) is worth $0.1 per pip movement, 10,000 lot (mini) is worth $1, and a 100, 000 lot (standard) is worth $10 per pip movement. This applies to all pairs where the USD is listed second (base currency).

Consider you have $10,000 account; trade risk is 1% ($100 per trade).

  • Ideal position size = [$100 / (61 * $1)] = 1.6 mini lots or 16 micro lots

Creating a Forex trading spreadsheet to track your performance

Creating and maintaining a forex trading spreadsheet or journal is considered a best practice, which not only helps an amateur forex trader but also a professional trader.

Why do we need it?

We need a trading spreadsheet to track our trading performance over time. It is important to have a way to track your results so that you can see how you are doing over a couple of trades. This also allows us to not get caught up on any particular trade. We can think of a trading spreadsheet as a constant and real reminder that our trading performance is measured over a series of trades not only based on one particular forex trade.

Not only we keep track of our trades with the help of spreadsheet, we keep track of trends with different currency pairs, day after day, without layers of technical indicators.

Consider this sample of a forex trading spreadsheet −

Spreadsheet

Documenting your forex trading activity is necessary and serves as a helpful component to becoming a professional forex trader.

Foreign Exchange Risks

Every country has its own currency just as India has the INR and the USA has USD. The price of one currency in terms of another is known as exchange rate.

The assets and liabilities or cash-flow of a company (like Infosys), that are denominated in foreign currency like the USD (US dollar) undergo a change in their value, as measured in domestic currency like the INR (Indian rupees), over a period of time (quarterly ,halfyearly etc.), because of variation in exchange rate. This change in the value of assets and liabilities or cash flows is called the exchange rate risk.

So, foreign exchange risk (also called “currency risk”, “FX risk” or “exchange risk”) is a financial risk that exists when the company financial transaction is done in currency other than that of the base currency of the company.

This uncertainty about the rate that would prevail on a future date is known as exchange risk.