What is Position Size in Trading?
Position size is VERY, VERY, VERY important when in comes on to risk management. Position size is also called lot size. It is the number of position/lots you are able to trade within your risk management guidelines. Professional traders have a maximum risk of 1 or 2 % of account balance.
In order to determine the position size there is some preliminary work that needs to be done.
Assume you have the set up conditions based on your strategy, you first need to establish how much is 1% or your account balance.
Let’s assume you have a $10,000 USD mini account. Your 1% risk in $ is US$100
($10,000 multiply by 1%).
Now that you know your risk in US$ you need to establish where you will place your stop loss order (the point at which you want to get out of a trade if it goes against you). Knowing where to put your stop loss order in advance is very important for calculating your position size.
You will also need to establish your entry price. The difference between your entry price and your stop loss order is your risk in pips/points.
When you have all of these information you will be able to calculate your position size using the following formula:
Risk in Dollars divide by risk in pips divide by pip value = POSITION SIZE
Example 1
Let take an example, you have a US dollar account amounting to $10,000 and you only want to risk 1% of your account balance which is $100 ($10,000*1%).
You get your set up condition on the GBP/USD. You identify that you need to place your stop loss at 1.3500 and that your entry price is 1.3530. From this information you are able to calculate your risk in pips/points. In this example your risk in pips is 30(1.3530-1.3500*10,000)
You now need to establish the pip value for the GBP/USD currency pair. As the second currency in the currency pair matches that of the account you are trading then 1 pip in a mini lot account would be equal to $1 per pip.
Now that you have all three pieces of information you are now able to calculate your position size.
Position size = Risk in dollars divide by risk in pip divide by pip value
Position size = £100 divide by 30 divide by 1
Position size = 3.33
This means that for every 1pip movement your account will be increasing/decreasing by US$ 3.33 per pip.
The fact that you are only risking 1% of your account size means you will have 99% of your money left in your account for you to trade again if your trade goes against you.
PLEASE NOTE! BEFORE YOU PLACE A TRADE, CHECK YOU ACCOUNT BALANCE AND CALCULATE YOUR 1% RISK AS YOUR ACCOUNT BALANCE WILL KEEP ON CHANGING.
Example 2
Let take an example, you still have your US dollar account amounting to $10,000 and you only want to risk 1% of your account balance which is $100 ($10,000*1%).
You get your set up condition on the USD/CAD. You identify that you need to place your stop loss at 1.2845 and that your entry price is 1.2870.
From this information you are able to calculate your risk in pips/points. In this example your risk in pips is 25 (1.2870-1.2845*10000).
You now need to establish the pip value for the USD/CAD currency pair. As the second currency in the currency pair does not match that of the account you are trading but the first currency does then you will have to calculate the pip value by dividing the fixed amount for mini lot I.e $1 by the USD/CAD rate of 1.2870. This will result in a pip value of .77 cents per pip. ($1/1.2870)
Now that you have all three pieces of information you are now able to calculate your position size.
Position size = Risk in dollars divide by risk in pip divide by pip value
Position size = £100 divide by 25 divide by .78
Position size = 5.13
This means that for every 1pip movement your account will be increasing/decreasing by $5.13
per pip.
Example 3
Let take an example, you still have your US dollar account amounting to $10,000 and you only want to risk 1% of your account balance which is $100 ($10,000*1%).
You get your set up condition on the USD/JPY. You identify that you need to place your stop loss at 109.00 and that your entry price is 109.70.
From this information you are able to calculate your risk in pips/points. In this example your risk in pips is 70 (109.70-109.00*100).
You now need to establish the pip value for the USD/JPY currency pair. As the second currency in the currency does not match that of the account you are trading but the first currency does then you will have to calculate the pip value by dividing the fixed amount for mini lot I.e $1 by the USD/JPY rate of 109.70 *100. This will result in a pip value of .77cents per pip ($1/109.70*100)
Now that you have all three pieces of information you are now able to calculate your position size.
Position size = Risk in dollars divide by risk in pip divide by pip value
Position size = £100 divide by 70 divide by .77
Position size = 1.86
This means that for every 1pip movement your account will be increasing/decreasing by $1.86
per pip.
Now you are ready to practice some examples on your own, so that you are able to do this quickly. Keep referring to these examples if you have to.