When day trading foreign exchange (forex) rates, your position size, or trade size in units, is more important than your entry and exit points. You can have the best forex strategy in the world, but if your trade size is too big or small, you'll either take on too much or too little risk. And risking too much can evaporate a trading account quickly.
Your position size is determined by the number of lots and the type and size of lot you buy or sell in a trade:
A micro lot is 1,000 units of a currency
A mini lot is 10,000 units
A standard lot is 100,000 units
Your risk is broken down into two parts trade risk and account risk. Here's how all these elements fit together to give you the ideal position size, no matter what the market conditions are, what the trade setup is, or which strategy you're using.
Set Your Account Risk Limit Per Trade
This is the most important step for determining forex position size. Set a percentage or dollar amount limit you'll risk on each trade. For example, if you have a $10,000 trading account, you could risk $100 per trade if you use the 1% limit. If your risk limit is 0.5%, then you can risk $50 per trade. Your dollar limit will always be determined by your account size and the maximum percentage you determine. This limit becomes your guideline for every trade
Most professional traders risk at most 1% of their account.
You can also use a fixed dollar amount, which should also be equivalent to 1% of the value of your account or less. For example, you might risk $75 per trade. As long as your account balance is $7,500 or more, you'll be risking 1% or less.
While other trading variables may change, account risk should be kept constant. Don't risk 5% on one trade, 1% on the next, and then 3% on another. Choose your percentage or dollar amount and stick with it—unless you get to a point where your chosen dollar amount exceeds the 1% percentage limit.
Plan for Pip Risk on a Trade
Now that you know your maximum account risk for each trade, you can turn your attention to the trade in front of you.
Pip risk on each trade is determined by the difference between the entry point and the point where you place your stop-loss order. A pip, which is short for "percentage in point" or "price interest point," is generally the smallest part of a currency price that changes. For most currency pairs, a pip is 0.0001, or one-hundredth of a percent. For pairs that include the Japanese yen (JPY), a pip is 0.01, or 1 percentage point. Some brokers choose to show prices with one extra decimal place. That fifth (or third, for the yen) decimal place is called a pipette.
A stop-loss order closes out a trade if it loses a certain amount of money. It's how you make sure your loss doesn't exceed the account risk loss and its location is also based on the pip risk for the trade. So, for example, if you buy a EUR/USD pair at $1.2151 and set a stop-loss at $1.2141, you are risking 10 pips.
Pip risk varies based on volatility or strategy. Sometimes a trade may have five pips of risk, and another trade may have 15 pips of risk.
When you make a trade, consider both your entry point and your stop-loss location. You want your stop-loss as close to your entry point as possible, but not so close that the trade is stopped before the move you're expecting occurs.
Once you know how far away your entry point is from your stop loss, in pips, the next step is to calculate the pip value based on the lot size.
Understand Pip Value for a Trade
If you're trading a currency pair in which the U.S. dollar is the second currency, called the quote currency, and your trading account is funded with dollars, the pip values for different sizes of lots are fixed. For a micro lot, the pip value is $0.10. For a mini lot, it's $1. And for a standard lot, it's $10.
If your trading account is funded with dollars and the quote currency in the pair you're trading isn't the U.S. dollar, you will have to multiply the pip values by the exchange rate for the dollar vs. the quote currency. Let's say you're trading the euro/British pound (EUR/GBP) pair, and the USD/GBP pair is trading at $1.2219.
For a micro lot of EUR/GBP, the pip value would be $0.12 ($0.10 * $1.2219)
For a mini lot, it would be $1.22 ($1 * $1.2219)
For a standard lot, it would be $12.22 ($10 * $1.2219)
The only thing left to calculate now is the position size.
Determine Position Size for a Trade
The ideal position size can be calculated using the formula:
Pips at risk * pip value * lots traded = amount at risk
In the above formula, the position size is the number of lots traded.
Let's assume you have a $10,000 account and you risk 1% of your account on each trade. Thus your maximum amount to risk is $100 per trade. You're trading the EUR/USD pair, and you decide you want to buy at $1.3051 and place a stop loss at $1.3041. That means you're putting 10 pips at risk ($1.3051 – $1.3041 = $0.001). Since you've been trading in mini lots, each pip movement has a value of $1.
If you plug those numbers in the formula, you get:
10 * $1 * lots traded = $100
If you divide both sides of the equation by $10, you arrive at:
Lots traded = 10
Since 10 mini lots are equal to one standard lot, you could buy either 10 minis or one standard.
Now let's go to an example in which you're trading mini lots of the EUR/GBP and you decide to buy at $0.9804 and place a stop loss at $0.9794. That again is 10 pips of risk.
10 * $1.22 * lots traded = $100
Remember, the $1.22 value comes from our above conversion formula in section three. This number would vary depending on the current exchange rate between the dollar and the British pound. If you divide both sides of the equation by $12.20, you arrive at:
Lots traded = 8.19
So your position size for this trade should be eight mini lots and one micro lot. With this formula in mind along with the 1% rule, you're well equipped to calculate the lot size and position on your forex trades.
Frequently Asked Questions (FAQs)
How do you hedge a forex position?
Traders have many options for forex hedging. Any trade that you expect to move in the opposite direction of your current forex position could be used as a hedge. The hedging trade can be another forex position, such as selling the dollar in one pairing and buying it in another pairing. The hedge can also take place in another market, such as through dollar index ETFs or futures contracts.
What is an open position in forex trading?
An open position is simply trade that you are still in. For example, if you start a trade by selling U.S. dollars for Japanese yen, then that trade is considered "open" until you trade the yen back for dollars. Day traders may open and close positions many times in a matter of hours.