How to Determine the Size of a Position When Dealing in Foreign Exchange

How to Determine the Size of a Position When Dealing in Foreign Exchange

Your position size, also known as your trade size in units, is more significant than both your entry and exit locations when you are day trading foreign currency (FX) rates. You could have the best forex strategy in the world, but if the size of your trades is too large or too tiny, you will either expose yourself to an unacceptable level of risk or not enough risk at all. And putting too much of your money on the line will soon wipe out your trading account.

The number of lots, as well as the type and size of lots that you buy or sell in a trade, are the factors that determine the size of your position.

  • One micro lot is equal to one thousand of a given currency’s units.
  • A tiny lot is 10,000 units.
  • A typical lot consists of 100,000 units.

Your exposure to risk is comprised of two distinct aspects: your trade risk and your account risk. Here is an explanation of how all of these factors work together to give you the right position size, no matter what the market conditions are, what your trade structure is, or what method you are using.

You can set a risk limit per trade for your account.

When it comes to determining the size of a forex position, this is the most crucial phase. You should restrict the amount of money you are willing to lose on each trade. Using the 1 percent limit, as an illustration, if you had a trading account with a balance of $10,000, you might potentially lose $100 on each trade. If you have a risk limit of 0.5 percent, then the most you can lose on a single trade is $50. Your monetary limit is always going to be based on the size of your account, in addition to the maximum percentage that you choose. This limit will be a guide for you in all the transactions you undertake.

The majority of experienced traders limit their risk to no more than 1% of their account balance.

You may alternatively utilize a predetermined monetary amount, but this sum must still be less than or equal to 1 percent of the total value of your account. You might, for instance, put $75 on the line with each deal. As long as the total amount in your account is $7,500 or more, the amount of risk you take on will be less than 1%.

Account risk should be maintained at the same level regardless of any changes to the other trade variables. Do not risk 5% of your money on one trade, 1% on the next, and 3% on the next. Make a decision on the percentage or the dollar number that you will use, and stick with it unless you reach a point where the dollar amount that you have chosen surpasses the limit of 1 percent.

Prepare for Point-and-Pip Risk in a Trade

Now that you are aware of the maximum amount of money that can be lost on each trade, you can focus your attention on the trade that is now being presented to you.

The difference between the position at which you enter the trade and the point at which you set your stop-loss order is what determines the pip risk for each individual trade. Pips, which can mean either “percentage in point” or “price interest point,” are often the smallest variable component of a currency’s price. Most currency pairs use the pip, which is equal to one hundredth of one percent, as the standard unit of measure. A “pip” is equal to 0.01, or one percentage point, for currency pairs that contain the Japanese yen (JPY). Different brokers may choose to display the rates with an additional decimal place. A pipette is a name given to the fifth (or third, for the yen) place in the decimal system.

A trade is terminated according to the stop-loss order if it falls below a predetermined loss threshold. It is how you ensure that your loss will not be greater than the account risk loss, and the location of it is also determined by the pip risk for the deal. If you buy a EUR/USD pair at $1.2151 and place a stop-loss order at $1.2141, for instance, you are exposing yourself to a loss of 10 pips.

The pip risk might change depending on the volatility of the market or the trading method. There are occasions when one trade can have a risk of five pips while another deal might have a risk of 15 pips.

When you make a trade, you need to think about both the point at which you enter the trade and the location of your stop-loss order. You want the stop-loss order to be as close to your entry point as is practically possible, but you don’t want it to be so close that the trade is terminated before the move that you are anticipating.

After you have determined, in terms of pips, how far apart your entry point and your stop loss are from one another, the next step is to compute the value of a pip depending on the lot size.

Before You Trade, You Should Learn the Value of a Pip.

If you are trading a currency pair in which the United States dollar is the second currency, also known as the quote currency, and your trading account is financed with dollars, then the pip values for different sizes of lots will always be the same. The point-in-figure value, or pip, for a micro lot, is $0.10. It costs one dollar for a small lot. In addition, the price for a regular lot is ten dollars.

If the quote currency in the pair you are trading is not the U.S. dollar, then you will need to multiply the pip values by the exchange rate that applies to the dollar in comparison to the quote currency. If your trading account is financed in dollars, then this step is not necessary. Suppose you are trading the euro against the British pound (EUR/GBP) pair, and the price of the USD against the GBP pair is currently $1.2219.

  • If you were trading EUR/GBP with a micro lot, the pip value would be $0.12 ($0.10 times $1.2219).
  • It would cost $1.22 for a tiny lot ($1 multiplied by $1.2219).
  • It would come to a total of $12.22 for a normal lot ($10 multiplied by $1.2219).

Now, the only thing that has to be computed is the size of the position.

Determine the Size of Your Position in a Trade.

The following formula can be used to determine the ideal size of a position:

The amount at risk is calculated by multiplying the number of lots exchanged by the number of pips at risk.

As shown in the calculation above, the size of a position is based on how many lots are traded.

Let’s say you have a trading account worth $10,000 and you put one percent of your balance at risk on each deal. Therefore, the most money you can put on the line in a single trade is $100. You decide to trade the EUR/USD currency pair, and you decide that the best price to purchase at is $1.3051, with a stop loss order set at $1.3041. This indicates that you are putting 10 pips ($1.3051 minus $1.3041 = $0.001) on the line. Due to the fact that you have been trading in small lots, each point of price change is worth $1.

If you enter those figures into the formula, you will obtain the following results:

10 lots sold at $1 each equals $100.

If you divide both sides of the equation by ten dollars, you will get the following results:

The lots traded are equal to 10.

Because one standard lot is equivalent to ten mini lots, you have the option of purchasing either one standard lot or ten mini lots.

Now let’s look at a hypothetical situation in which you are trading micro lots of the EUR/GBP currency pair and you make the decision to purchase at $0.9804 and set a stop loss at $0.9794. This again constitutes a risk of 10 pips.

10 lots at $1.22 each, multiplied together, equals $100.

Keep in mind that the value of $1.22 was derived using the conversion procedure that was shown in Section Three above. This value would alter depending on the current exchange rate that exists between the United States dollar and the United Kingdom pound. When both sides of the equation are divided by $12.20, the following answers are found:

The number of lots traded was 8.19.

Therefore, the appropriate position size for this trade would be eight mini lots and one micro lot on your part. You should feel confident in your ability to determine the lot size If you keep this formula in mind and also keep the 1 percent guideline in mind.

Questions That Are Typically Asked (FAQs)

How do you hedge a position while trading forex?

Forex traders can choose from a wide variety of hedging strategies. A hedge can be defined as any trade that you enter into with the expectation that it will move in the opposite direction of your present currency position. The hedging trade may take the form of an additional forex position, such as selling the dollar against one currency pair and purchasing it against another currency pair. Hedging activity can alternatively take place in a different market, such as by using exchange-traded funds (ETFs) that track the dollar index or futures contracts.

In foreign exchange trading, what is meant by the term “open position”?

A deal that you are still involved in is referred to as an “open position.” For instance, if you initiate a transaction by exchanging dollars from the United States for yen from Japan, then that trade is deemed “open” until you exchange the yen for dollars again. During the course of a single trading day, day traders often open and close positions.

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