Updated: Apr 8, 2022
Trading is not only about analysis, it’s about so much more. Most people only focus on teaching you the technicals of trading because this is the easiest thing to teach. However, if you are serious about becoming good at Forex trading, there are other things you need to learn and study. One of these things is position sizing. Position sizing has a massive impact on the results you get from Forex trading. In this article you are going to read about why it’s important to position size the correct way, but also how to do it the correct way.
Why is position sizing important?
Position sizing is import for a couple of reasons. Position sizing allows you to be bigger in your winning trades and smaller in your losing trades. It also allows you to allocate risk the way you want it to allocate. Next to that, position sizing helps you to build positions as you can scale in. So, position sizing really is a tool to allocate risk the way you want it, in order to maximize profits and minimize losses. Position sizing is not just a tool to calculate how much you want to risk and enter the markets. This is flawed thinking. Position sizing is another tool you can use to get better at risk management in Forex trading.
If you learn how to position size correctly you can increase your performance in Forex trading in a safe way, without risking too much.
Different ways to size your position in Forex trading
There are different ways to size your positions in Forex trading. Most people use a so called lot size calculator to determine how big the position size has to be. This is a good tool. However, most people stick to that. There is so much more to it. When you want to size your positions in an optimal way you have to think about a few things, these things are:
Risk of ruin
These are the things that you need to think about when it comes to position sizing in Forex trading. As you can see, there is a lot more to it than most people will tell you.
Your account size
The account size is important. Why? Because when you are trading a small account position sizing is very hard. You can’t trade half of a micro lot. This means you have to round up. There is nothing wrong with that. However, if you round up to the upside on all of your losing trades, but round down on your winning trades you are risking less on your winners and more on you losers. You might thing, would anyone do that? Before you enter a trade you don’t know if it’s going to win. Therefore, you round up or down, depending on the size. A small account size can make it really hard to figure out if you have an edge in trading.
Let’s give you an example:
You want to go long on the EURUSD. You want to risk 1% on this trade and calculate the correct position size. The size that comes out is 0.015. Because brokers don’t allow you to trade that 0.005 you round up to 0.02. You are now risking more than you should. If this turns out to be a loser you lost more than the 1% you risked. If you risked 0.01 and it became a winner you won less than you should.
This means you are dependent on luck, which is not a good strategy. Therefore, trading a small account in Forex trading is very hard. Get enough money to position size correctly in order to let your edge play out.
The next point is edge. You need an edge to win at Forex trading. However, edges work better during some occasions and worse during other occasions. What you want to do is risk more when your edge works better and risk less when it doesn’t work as good. To do this you need a trading journal. It’s up to you to figure out when your edge works best. Then, you want to risk more when it does. Without an edge in trading, risk management and all the other things won’t really matter.
Your risk of ruin
The risk of ruin is something we spoke about earlier in another article. The risk of ruin is the odds of you blowing your account if you keep trading a certain strategy at a certain risk level. When you are going to size your position in Forex trading you never want to risk as much as your risk of ruin level. Stay well below it and leave room for error. If you want to know how to calculate this you should read the other blog we wrote about this concept.
Taking into account certain risk parameters is also very important when it comes to position sizing in Forex trading. Every should have certain risk parameters. For example, you can have:
Daily stop levels
Weekly stop levels
Max exposure levels
These are just some risk parameters that exist in Forex trading. Especially if you are trading for a firm you should know these and follow these. The only way to follow these is to know them and calculate your position size correctly by taking into account these risk parameters. Let’s say your maximum exposure is a 1 lot. How are you going to allocate your risk and calculate your position size if you have 4 different trading setups with different probabilities? This is something you need to think about before you start trading. Most people overlook this and most people don’t talk about this. But if you want to be succesful at Forex trading you need to be prepared and put all the odds in your favor.
Money management can help you with increasing your performance. There are a lot of different ways to manage your money when it comes to Forex trading. Money management is the way you are going to risk on every single trade. Yes, you risk more on what works best and less on what doesn’t work as good. However, there are also certain things you can do to increase your performance even more when it comes to money management in Forex trading. Below are some techniques you can use:
These are all different sorts of money management techniques you can apply. Each of these has it’s pros and cons. We at CDFX Trading use the Kelly criterion.
The Kelly criterion
The Kelly criterion is a formula, based on winrate and payout, and allows you to maximize your profits without increase risk on certain trades and increase the volatility of your equity curve. Kelly is the optimal bet size. However, Kelly is very big. When calculating Kelly you often find you should risk 30% a trade or something. This is ridiculous. This does not leave any room for the law of large numbers to play out.That’s why we use a fraction of the Kelly criterion. For example, you can use 1//20th of the Kelly criterion.
The formula for the Kelly criterion is as followed: K%=Winrate-(1-Winrate)/Average R
When you use this formula and you get the answer from it, divide it with a certain number to make it fit within your risk of ruin and other risk parameters. Next up you want to allocate more Kelly towards your better setups and less towards the setups that perform less.
This is exactly how we do it at CDFX Trading. We risk a fraction of Kelly to maximize profits without increasing volatility. We risk within our risk of ruin and we allocate more to our edge when it performs better. This is the holy grail in Forex trading in our opinion. You have to change nothing about your strategy, but only about how you risk your money. This is how you increase the strenght of your trading edge.
The other ways of money management also have their place in Forex trading. However, we didn’t find them beneficial for our way of trading. It’s important to notice that there is no one size fits all. Therefore, you need to do your own research. Learn about different money management techniques and test things out. What works best? We don’t like to give you the clear cut answer, as you won’t learn from that. Take action for yourself, it’s up to you.
The way you size your positions and manage your money can have a massive impact on your performance and the strength of your trading edge in Forex trading. You now know certain tools you can use to work on your money management & position sizing in order to become better at Forex trading. Reading this article is not enough, you need to take action and test things out, it’s the only way.
If you want to take your Forex trading to the next level you might want to consider our 5 month, 1-on-1 coaching program. During this program you will learn all the tools you need to learn in order to become a consistently profitable Forex trader.
If you have any questions about the things spoken about in this article, or you want to know more about other Forex trading related things, feel free to contact us! We love to help!