Position Sizing Techniques That You Can Follow to Improve Your Forex Trading
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Undoubtedly, it is the dream of many forex traders to seize huge winning trades- which are double or even triple their initial trading capital. However, in reality, trades with 10X or 20X returns are quite rare in forex trading. While they might happen, they can also enhance your chances of your trading capital getting completely wiped out; the situation can be disastrous if you invest every single penny in one particular trade, thinking it will be the big one.
Therefore, rather than risking your entire hard-earned money on a single trade, it is better to utilize some effective position sizing techniques within your trading strategy. Many successful forex traders have realized the significance of position sizing for a successful trading career. This is true; without proper position sizing techniques, you might risk a lot of your trading capital. Consequently, the bigger risk you take on a trade, the bigger the chances of your trading account getting wiped out completely.
While the opposite might sometimes happen, that the trade will lead to huge wins, many experienced traders say that you would be better off limiting your position size rather than increasing your risks needlessly. So, let’s know what position sizing is and plunge into the most effective position sizing techniques that can help you improve your trading.
What’s A Position?
In forex trading, the position is the amount of currency that a trader holds. Talking about open positions, a trader might be either short or long. For instance, if you have opened a long position of 1.0 Lot in EUR/USD, it means that you are long €100,000 against the USD. Similarly, a trader who has closed their position(s) is also referred to as being flat or square.
What Is Position Sizing?
In simple words, position sizing refers to setting the ideal trade size to compute the dollar amount that the trader must utilize to open a new trade. Although it sounds simple, it is not so. Before you enter the trade, you need to be aware of the risk amount that you are taking and how it can affect your trading account. Furthermore, traders must constantly monitor their positions to make sure everything is under control.
Significance of Position Sizing:
Opening positions with random position sizes can turn out to be disastrous. However, having a sound risk management plan can minimize the chances of losing a good portion of your trading capital. Additionally, you can focus on all your open positions, which can be especially beneficial for short-term traders who need to react quickly to price changes. Position sizing is also helpful to maximize your performance by helping traders find the right balance. Thus, they can maximize their profits while keeping the losses at bay.
Proper position sizing techniques can help traders find the right approach to enter and exit the trades. Here are the best position sizing techniques you can use for improving your trading:
- Fixed dollar value:
Fixed dollar value is the simplest way to implement position sizing into your trading strategy. The technique is ideal for new traders or those with less capital. All you need to do is allocate a fixed amount in dollars to each trade you take. Thus, it automatically curtails the risk you take per trade. Additionally, it preserves your capital if the first few trades turn into losses.
- Fixed percentage risk per trade:
Fixed percentage risk per trade is another position sizing technique that many traders use. Here, you risk a small proportion of your whole trading capital on every trade. As a rule of thumb, the traders can put 1-2% per trade risk.
- Contract size value:
Many traders use this contract size value to restrict their risks. It is an efficient method to control your risk while getting sufficient exposure to the market. Contract sizes can differ from broker to broker. However, the most common of them all are standard contracts, mini contracts as well as micro contracts. As a beginner, you should trade small-size contracts initially and then switch to the standard contract sizes.
- Leverage:
Leverage is the main trading technique that lures traders to the forex market. However, everyone knows that leverage is a double-edged sword; thus, it has the potential to magnify both profits and losses. Leverage is available in ratios such as 20:1, 50:1, 100:1 and so on. However, when it comes to leverage, traders should never have to use the highest leverage just because it is on offer. It’s better to stick to low leverage to limit your risk exposure. If you use high-leverage, you risk losing your capital if a particular trade goes against you.
- Kelly Criterion:
Here is the formula for Kelly Criterion:
Kelly in % = W – [(1-W)/R]
It computes the % of your trading account that you must risk. The percentage you calculate from the formula is the position you need to take. For instance, getting 0.06 means, you can risk 6 % of your capital for each trade.
