The Importance of Correct Position Sizes

Now that we've learned the hard lesson of trading too big, let's get into how to correctly use leverage using proper "position sizing."

Position sizing is setting the correct amount of units to buy or sell of currency pair.

It is one of the most crucial skills in a trader's skill set.

Actually, we'll go ahead and say it is THE most important skill.

Traders are "risk managers" first and foremost, so before you start trading real money you should be able to do basic position size calculations in your sleep... or at least after you wake up, still groggy, and try to trade the NFP report!

Finding the position size that will keep you within your risk comfort level is relatively easy...and we use the phrase "relatively easy" loosely here. Besides, if Pipcrawler, who can't tell his pinkies from his toes, can do it, then you can too!

Depending on the currency pair you are trading and your account denomination (is your account in dollars, euros, pounds, etc??), a step or two needs to be added to the calculation.

Now, before we can get our math on, we need five pieces of information:

1. Account equity or balance
2. Currency pair you are trading
3. The percent of your account you wish to risk
4. Stop loss in pips
5. Conversion currency pair exchange rates

Easy enough right? Let's move on to a few examples.

Calculating Position Sizes

To make things easier for you to understand, as usual, we'll be explaining everything with an example.
Long time ago, back when he was even more of a newbie than he is now, he blew out his account because he put on some enormous positions.
It was as if he was a gun slinging cowboy from the Midwest - he traded from the hip and traded BIG.
Ned didn't fully understand the importance of position sizing and his account paid dearly for it.
He re-enrolled into the School of Pipsology to make sure that he understands it fully this time, and to make sure what happened to him never happens to you!
In the following examples, we'll show you how to calculate your position size based on your account size and risk comfort level.
Your position size will also depend on whether or not your account denomination is the same as the base or quote currency.

Account Denomination the same as the Counter Currency

Newbie Ned just deposited USD 5,000 into his trading account and he is ready to start trading again. Let's say he now uses a swing trading system that trades EUR/USD and that he risks about 200 pips per trade.
Ever since he blew out his first account, he has now sworn that he doesn't want to risk more than 1% of his account per trade. Let's figure how big his position size needs to be to stay within his risk comfort zone.
Using his account balance and the percentage amount he wants to risk, we can calculate the dollar amount risked.
USD 5,000 x 1% (or 0.01) = USD 50
Next we divide the amount risked by the stop to find the value per pip.
(USD 50)/(200 pips) = USD 0.25/pip
Lastly, we multiply the value per pip by a known unit/pip value ratio of EUR/USD. In this case, with 10k units (or one mini lot), each pip move is worth USD 1.
USD 0.25 per pip * ((10k units of EUR/USD)/(USD 1 per pip)) = 2,500 units of EUR/USD
So, Newbie Ned should put on 2,500 units of EUR/USD or less to stay within his risk comfort level with his current trade setup.
Pretty simple eh? But what if your account is the same as the base currency? 

Account Denomination the same as Base Currency

Let's say Ned is now chilling in the euro zone, decides to trade forex with a local broker, and deposits EUR 5,000.
Using the same trade example as before (trading EUR/USD with a 200 pip stop) what would his position size be if he only risked 1% of his account?
EUR 5,000 * 1% (or 0.01) = EUR 50
Now we have to convert this to USD because the value of a currency pair is calculated by the counter currency. Let's say the current exchange rate for 1 EUR is $1.5000 (EUR/USD = 1.5000).
All we have to do to find the value in USD is invert the current exchange rate for EUR/USD and multiply by the amount of euros we wish to risk.
(USD 1.5000/EUR 1.0000) * EUR 50 = approx. USD 75.00
Next, divide your risk in USD by your stop loss in pips:
(USD 75.00)/(200 pips) = $0.375 a pip move.
This gives Ned the "value per pip" move with a 200 pip stop to stay within his risk comfort level.
Finally, multiply the value per pip move by the known unit-to-pip value ratio:
(USD 0.375 per pip) * [(10k units of EUR/USD)/USD1 per pip)] = 3,750 units of EUR/USD
So, to risk EUR 50 or less on a 200 pip stop on EUR/USD, Ned's position size can be no bigger than 3,750 units.
Still pretty simple, eh?
Well now it gets slightly more complicated.
Don't worry though. The FX-Men got yo' back and we'll explain everything so it'll become as easy as baking a cake. 

Complex Position Sizing

In this lesson, we'll teach you how to calculate for pairs in which your account denomination isn't one of currencies in the pair currency pair that you wanna trade.

Account Denomination is not in the Currency Pair traded, but the same as the Conversion Pair's Counter Currency.

Ned is back in the U.S., (we think that he's actually a super spy just like Forex Ninja, traveling and saving the world in his free time) and today he decides to trade EUR/GBP with a 200 pip stop. To find the correct position size, we need to find the value of Ned's risk in British Pounds.
Remember, the value of a currency pair is in the counter currency.
Okay let's straighten things out here. He's back trading with his U.S. broker selling EUR/GBP and he only wants to risk 1% of his USD 5,000 account, or USD 50.
To find the correct position size in this situation, we need the GBP/USD exchange rate. Let's use 1.7500 and because his account is in USD, we need to invert that exchange rate to find the proper amount in British Pounds.
USD 50 * (GBP 1/USD 1.7500) = GBP 28.57
Now, we just finish the rest the same way as the other examples. Divide by the stop loss in pips:
(GBP 28.57)/(200 pips) = GBP 0.14 per pip
And finally, multiply by the known unit-to-pip value ratio:
(GBP 0.14 per pip) * [(10k units of EUR/GBP)/(GBP 1 per pip)] = approximately 1,429 units of EUR/GBP
Ned can sell no more than 1,429 units of EUR/GBP to stay within his pre-determined risk levels.

Account Denomination is not in the Currency Pair traded, but the same as the Conversion Pair's Base Currency.

Ned decides to go snowboarding in Switzerland, and in between a couple of double black diamond runs, he opens up his trading account on his super spy phone with a local FX broker. He sees a great setup on CHF/JPY, and he has decided that he will get out of the trade if it goes beyond a major resistance level--about 100 pips against him. Ned will only risk the usual 1% of his CHF 5,000 account or CHF 50. 

First, we need to find the value of CHF 50 in Japanese yen, and since the account is the same denomination as the conversion pair's base currency, all we have to do is multiply the amount risked by CHF/JPY exchange rate (85.00):
CHF 50 * (JPY 85.00/ CHF 1) = JPY 4,250
Now, we just finish the rest the same way as the other examples. Divide by the stop loss in pips:
JPY 4,250/100 pips = JPY 42.50 per pip
And finally, multiply by a known unit-to-pip value ratio:
JPY 42.50 per pip * [(100 units of CHF/JPY)/(JPY 1 per pip)] = approximately 4,250 units of CHF/JPY
Shabam! There you have it!
Ned can trade no more than 4,250 units of CHF/JPY to keep his loss at CHF 50 or less.