Position-sizing refers to the size of the trade that you undertake.
It is so important to trading success that entire books have been written on this one subject.
The most famous of these is Dr Van Tharp’s ‘Definitive Guide to Position Sizing Strategies,’ which is considered the ultimate book on this subject.
In fact, Dr Van Tharp coined the term ‘position sizing,’ so he is considered the father of position size strategies.
Here we explain why position-sizing is so important, and break down the various aspects of position-sizing that you need to know as a forex trader.
We’ll also give you valuable information and advice about the best method to use to determine your position size, and which method may be right for your trading style.
What is position-sizing?
Position-sizing involves determining the amount of capital to allocate to a single trade.
It is a critical component of risk management in any form of trading that you undertake.
Position-sizing is all about striking a balance between risk and reward.
It’s essential to determine how much of your trading account you’re willing to risk on any one trade.
This will vary depending on your risk tolerance and trading strategy.
By correctly sizing your trade positions, you can protect your account from significant losses and optimise your profitability.
This article will explore various methods to determine position size, using insights from legendary trading coach Dr Van K. Tharp from his book ‘Definitive Guide to Position Sizing Strategies.’
Why position-sizing is so important
Position-sizing helps traders manage their risk to ensure that no single trade will significantly negatively impact their trading capital.
It plays a crucial role in:
- Controlling risk
One of the primary reasons for employing effective position-sizing is risk management.
By allocating an appropriate portion of your trading capital to each trade, you can limit your exposure to adverse market movements.
In addition, by setting a maximum loss per trade, you can protect your trading capital from large drawdowns.
Position-sizing achieves both of these aims in one go, by ensuring you don’t open a trade that is too big a risk for your trading account, and by ensuring that if the trade does go against you, that you don’t lose too much on any one trade.
- Optimising returns
Position-sizing also plays a crucial role in maximising your trading returns.
By optimising the size of each trade, you can ensure you are adequately exposed to profitable opportunities without taking on excessive risk.
Properly-sized positions maximise your returns by balancing risk and reward.
If you take on too large a position, you increase the risk of getting wiped out.
On the other hand, if your position size is too small, it will take longer, and you’ll have to work harder and place more trades in order to become profitable.
- Assisting with emotional control
Consistent position-sizing (calculated by a clearly-defined set of rules,) will assist you to avoid emotional decision-making and maintain your trading discipline.
By defining the risk-per-trade in advance, you can make more rational decisions and avoid impulsive actions driven by strong emotions such as fear or greed.
Key factors influencing position size
Account size
The size of your account is crucial when determining your position size.
Larger accounts can allow an individual to allocate more capital to individual trades, giving you more flexibility in your trading strategy.
On the other hand, if you have a smaller account, you’ll need to be more conservative to avoid excessive risk and potential drawdowns.
Leverage
Leverage allows you to control a larger position with a relatively small amount of capital.
In forex trading, leverage is often expressed as a ratio, such as 50:1, 100:1, or even higher.
This means that with a leverage of 100:1, you can take a $100,000 position with just $1,000 of your own capital.
Challenge rules
For prop traders, the challenge rules have a significant impact on position size.
Prop traders need to ensure the size they trade fits the challenges they are taking.
The impact of leverage on position size
Leverage directly impacts the size of the positions you can take, increasing your ability to open larger positions with less capital.
With higher leverage, you can open a larger position without needing a proportionately larger amount of trading capital.
The amount of money you are required to have in your trading account in order to finance a particular trade is known as your margin.
For example, if you have $10,000 in your trading account and you’re using 50:1 leverage, you can in theory trade positions up to $500,000.
In this case, your margin would be $10,000.
However, using such high leverage is not recommended for novice traders.
Increased risk using leverage
While leverage can amplify your gains, it also increases your risk.
The larger your position size, the more significant the impact of market movements on your account balance.
If you are over-leveraged, a small adverse price movement can lead to substantial losses, potentially wiping out your account.
Risk tolerance
Your risk tolerance is influenced by your trading experience, financial goals, and psychological makeup.
If you have a higher risk tolerance, you might opt for larger position sizes, aiming for higher returns.
Conversely, if you have a lower risk tolerance, you should consider smaller position sizes to mitigate risk and protect your capital.
Stop-loss order position
Where you place your stop-loss order is intrinsically connected to your position size, as this will also affect the loss you’re prepared to take per trade.
Position size and the placement of your stop-loss go hand-in-hand, and need to be calculated together in tandem with each other.
For example, the position size you would take is very different on a trade where you are risking a 150-pip loss, from one where you are risking a 15-pip loss.
Market volatility
Market volatility also plays a significant role in position-sizing.
In highly volatile markets, smaller position sizes are safer in order to prevent sudden large losses.
This approach helps you manage risk and protect your account during unpredictable market conditions.
In more stable markets, you might increase your position size to capitalise on predictable trends, and so maximise your returns.
Trade expectancy
Trade expectancy refers to the average amount you can expect to win or lose per trade.
It is calculated by multiplying the probability of winning, by the average win, and subtracting the probability of losing, multiplied by the average loss.
A positive expectancy indicates a profitable trading strategy.
Adjusting your position size according to trade expectancy can help optimise your returns and ensure that your strategy remains profitable in the long run.
How to decide position size
There are many available methods to decide what your position size is going to be when trading both forex and CFDs.
Each method has its advantages and disadvantages.
You should choose the one that is right for you based on your risk tolerance, your trading strategy, market conditions and experience.
Position sizing strategies
1. Fixed dollar amount
The fixed dollar method involves risking a predetermined dollar amount on each trade, regardless of your account balance.
This approach is simple and easy to implement.
Once you’ve decided how much you’re prepared to risk per trade, then you calculate your position size so that if the trade does go against you, then you only end up losing the amount you’re comfortable with.
Example:
Decide to risk a maximum of $100 per trade.
If you have a $10,000 account and decide to risk $100 per trade, and the stop-loss for the trade is set at 50 pips, the position size is calculated as follows:
- Dollar amount risked per pip = $100 / 50 pips = $2 per pip
- If you are trading a currency pair where each pip is worth $10 for a standard lot, you would trade 0.2 lots (mini-lots) to risk $100.
The advantage of this method is that it’s an easy one to implement for beginner traders, and works well with small trading accounts, say under $15,000.
However, if your account grows to over $15,000 – $20,000, consider another method to use, or increase your dollar risk per trade to take into account your larger account balance.
2. Fixed percentage of account equity
This method involves risking a fixed percentage of your account balance on each trade, and calculating your position size so this fixed percentage risk is never exceeded.
For example, novice traders may risk 0.5% of their account, while more experienced traders may choose to risk 1-2% per trade.
As your account balance changes, the position size is adjusted accordingly.
The advantage of this method is that it does take your trading capital into account, whereas the fixed dollar method does not.
One disadvantage is that as your account size grows, it may involve taking more risk than you are comfortable with.
For example, if your account grows to $150,000, and you’ve decided on a 2% risk, this will mean risking $3,000 per trade, which may be a higher risk than you’re prepared to take.
3. Volatility-based position- sizing
This method adjusts the position size based on the market’s volatility, measured by indicators like the Average True Range (ATR).
The result is that higher volatility leads to smaller positions, while lower volatility allows for larger positions.
Example:
For this example, let’s assume you have an account balance of $10,000.
Here’s how to calculate your position size based on market volatility, as measured by the Average True Range indicator.
Step 1: Define your risk per trade
Decide the percentage of your account balance you are willing to risk on a single trade.
A common risk percentage is 1%.
So, for a $10,000 account, your risk amount is:
Risk Amount = Account Balance × Risk Percentage
Risk Amount = $10,000 × 0.01 = $100
Therefore, the amount you will afford to risk per trade is $100.
Step 2: Find out the ATR
Use your charting software or trading platform to determine the Average True Range (ATR) of the asset you want to trade.
You can easily do this by using the ATR indicator.
For this forex example, we’ll assume an ATR of 14, which means the pair moves on average 14-pips per session (depending on the timescale of the chart you’ve chosen.)
Therefore, if you’re looking at a 15-minute chart, and the ATR is 14, it means on average that pair moves up or down by 14-pips within the 15-minute timescale you’ve chosen.
Naturally this means the lower the timeframe of the chart you’re looking at, the more responsive and accurate the ATR will be.
Step 3: Determine the pip value
The pip value varies depending on the currency pair and the lot size you are trading.
For a standard lot (100,000 units) in the EUR/USD pair, the pip value is typically $10 per pip.
For a mini-lot (10,000 units), the pip value is $1 per pip.
Step 4: Calculate the position size
To find out how many lots you should trade, divide your risk amount by the product of the ATR in pips and the pip value:
Position Size (lots) = Risk Amount divided by ATR (in pips) × Pip Value
For a mini-lot, where the pip value is $1:
Position Size (mini-lots) = $100 divided by 14 × $1 = 7.14 mini-lots
So, with an ATR of 14-pips and a pip value of $1, you should trade approximately 7.14 mini-lots to stay within your risk tolerance of only losing $100 if the trade goes against you.
4. Fixed ratio position-sizing
This method involves increasing your position size as your account grows, based on a fixed ratio.
You decide on an increment (called the Delta,) which determines how much the account must grow before increasing the position size.
For example, a Delta of $1,000 means that for every $1,000 of profit you make, your position size increases by a set increment, say 0.1 of a mini-lot.
Therefore, after earning $1,000 in profit, your position size might increase from one mini-lot, to 1.1 mini-lots, then to 1.2 mini-lots after another $1,000 profit, and so on.
Example:
If you start with a $10,000 account and a Delta of $1,000, and risk 1% of your account per trade, when the account grows by $1,000, you increase your position size by one mini-lot (0.1 lots.)
By using fixed ratio position sizing with a Delta, traders can systematically grow their position size in line with their account balance, which provides a balance between risk and reward.
The advantage of this method is that it does take your account balance into consideration, and provides a clear rule for when to increase your position size.
The disadvantage is that it requires complex calculation which may over-complicate things for novice traders.
This is not a method for determining position size that I have used in my personal trading career, but is included here for reference.
5. Standard lot size for all trades
Some forex traders prefer to use a standard lot sizes for simplicity.
This method is less flexible and can expose you to higher risk, especially with smaller accounts.
Example:
If you have a $10,000 account and decide to trade one mini-lot (0.1 lots) for all trades, and your stop-loss is set at 50 pips, you risk:
Dollar amount risked per pip = $10 (for a standard lot) / 10 (mini-lot) = $1 per pip
Total risk per trade = $1 per pip * 50 pips = $50
However, this method may result in inconsistent risk, as not all forex pairs are of equal monetary value.
6. Risk/reward ratio method
This method involves deciding on a predetermined risk/reward ratio to calculate your position size, for example a risk/reward ratio or 1:3 or 1:5.
Once you’ve defined your acceptable risk/reward ratio, you adjust your position size to match your desired ratio.
Example:
If you have a $10,000 account and aim for a risk/reward ratio of 1:3, risking 1% per trade ($100) with a target reward of $300:
Stop-loss distance in pips: 50 pips
Take-profit distance in pips: 150 pips
Dollar amount risked per pip = $100 / 50 pips = $2 per pip
Position size for a currency pair where each pip is worth $10 for a standard lot = 0.2 lots (mini-lot)
7. Position-sizing model based on your objectives and goals
This is a more complex method of determining your position size, as outlined by my colleague Sam in the MarketMates’ ‘Advanced Course for Smart Forex Traders 2.0.’
It is a method of aligning your position-sizing model with the objectives and goals you’ve set for your trading system.
You can find out more information about how to use this method here.
The aim is to establish your 1R risk per trade, and then convert that into a specific amount of currency.
Your 1R risk is the number of pips you are prepared to lose on any given trade.
For example, in the calculation we used above, your 1R risk would be 50-pips.
To calculate your position size, you’ll need the following details from your trading plan:
- Your desired return
- The maximum drawdown you’re prepared to take
- The number of trades you intend to make in a set period
- Your system win rate
- Your preferred risk/reward ratio
Additionally, you’ll need to know the amount of trading capital you have available.
Calculating your position size taking leverage into account
When determining your position size, you also need to consider the leverage you’re using.
Here’s a step-by-step method to calculate position size taking leverage into account:
- Determine your risk per trade (using the percentage method): Decide the percentage of your account you are willing to risk on a single trade. Commonly, experienced traders risk 1%-2% of their account balance per trade. Novice traders should reduce this risk to 0.5% of their account balance.
- Calculate your dollar risk: Multiply your account balance by your chosen risk percentage. For example, with a $10,000 account and a 2% risk per trade, your dollar risk amount is $200.
- Determine your stop-loss distance: Decide how many pips you are willing to risk on a trade. This depends on your trading strategy and the current market conditions.
- Calculate the pip value: The pip value varies depending on the currency pair and the size of your position. For a standard lot (100,000 units), one pip is usually worth around $10 for most currency pairs.
- Determine your position size: Divide your dollar risk by the pip value, multiplied by the stop-loss distance.
This gives you the size of the position you can take.
For example, if your dollar risk is $200, your stop-loss distance is 50 pips, and the pip value is $10, your position size would be:
$200 / (50 x $10) = 0.4 standard lots or 40,000 units.
Example using leverage
Assume you have a $10,000 account, want to risk 2% per trade, and use 100:1 leverage.
Your risk per trade is $200.
With 100:1 leverage you can take a position size up to 100 times your account balance.
Maximum Position Size = Account Balance × Leverage
Maximum Position Size =$10,000 ×100 =$1,000,000
With 100:1 leverage, you can control up to $1,000,000 in currency units.
However, to manage your risk appropriately while risking 2% of your account and considering a 50-pip stop-loss, the maximum position size you should trade is 0.4 standard lots.
The risk on a $1M position remains the same as if you were trading without leverage, underscoring the importance of careful risk management when using leverage.
Choosing the right position-sizing strategy for your trading
Selecting the right position-sizing method depends on your experience, individual trading goals, risk tolerance, leverage, and market conditions.
When making your choice about which method to use, think about the following factors:
- Account size: Smaller accounts may benefit from a fixed percentage or a fixed dollar method for simplicity, and to maintain consistent risk
- Trading strategy: Different strategies may require different position-sizing approaches. For example, scalpers may prefer fixed dollar amounts, while swing traders may prefer volatility-based position-sizing.
- Risk tolerance: Conservative traders may prefer methods that limit risk, such as fixed dollar, fixed percentage or volatility-based sizing, while aggressive traders may prefer a fixed ratio method.
Final thoughts about position size
Position-sizing is a fundamental aspect of forex and CFD trading that can significantly impact your success.
By understanding various position-sizing methods, you can decide which one best fits in with your own trading style.
In my trading, I always used the fixed-dollar loss method, as I found it quick and simple to calculate as a day-trader making multiple trades per day.
Implementing a robust position-sizing strategy is essential for long-term trading success.
By doing so, you can protect your capital, reduce emotional decision-making, and enhance your potential for success.
The complexity of the system you use to determine your position size is up to you.
It’s possible to safely trade having a very simple rule for position-sizing, such as a fixed $100-loss rule.
You then calculate how many units or lots to purchase based on this simple premise.
However, such a simple system may not suit more experienced traders, who may wish to take more elements of their trading plan into account when determining their position-size.
As always, the best method to use is personal to you, and your trading system.
The main thing to remember is that trade position-size is crucial, it is linked to other aspects of your risk management, and it must be kept consistent.
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Sources
Marketmates uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial guidelines to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy.
- Dr Van K. Tharp – Definitive Guide to Position Sizing Strategies. https://www.amazon.com.au/Definitive-Guide-Position-Sizing-Objectives/dp/0935219099
