Proper position sizing is something many traders never even think of, let alone learn to master.To determine our positions size we must first set a stop level. This should be a logical place which will be out of range of normal market movements, and if hit will be at a level where we know we are wrong about the direction of the market. Remember, a trader should not risk more than 1-2% of capital on a trade. Less is better. Larger accounts are likely to risk much less than 1% of capital on many trades. They may do this by selecting a fixed dollar stop which is less than 1% of their account.
If our account is $5000, we can have a maximum loss of $100 if we risk 2% of our capital on the trade. Let’s say we choose a stop which is 50 pips below our entry buy price. From this information we can determine our proper position size; we can take a maximum of 2 mini lots. If our stop is hit, we will lose 50 pips X 2 mini lots, or $100 which was our maximum loss.
Taking 2 mini lots on this trade allows us to have an ideal stop (this will be different for each trade) and keep our risk in check. As our stop (or risk level) increases on the trade, our position size will decrease, and as our risk (on the trade) decreases our position size can increase. As our account grows our position sizes will also generally increase as we are able to risk more capital on each trade.
Whether we risk a percentage of our account on each trade, or choose a fixed dollar amount we are willing to risk on a trade (for larger accounts) the method above should be employed to determine the proper position size based on the stop level which is ideal for the trade. This means each trade may be for different quantities, depending on the dynamics of the trade set up.
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Best,
Ron Chernesky
