An interesting article came across in Forex magazine with the title “Perfect size”.
Determination of currency volume, stocks or commodity futures, to which the deal is made – this is a commonly overlooked aspect of trading. Traders very often choose a random position size. They can take more volume, if you feel “really confident” regarding the deal, or less volume, if you don't feel so confident. but, this – very unreliable way of determining position sizing. Trader also should not set a hard position size for all cases. Many traders set the same position size regardless of the technical parameters of the trade., and a similar trading style will be, probably, lead to a decrease in trading efficiency in the long term.
What affects position size
Let's take a look, how the position sizing should actually be determined. Before moving on to sizing a position, we have to calculate the stop order level for the trade being made. Stop order must not be placed at a random level Stop order must be placed at a technically determined level, the achievement of which will indicate to the trader, that he was wrong about the direction of the trade. We shouldn't place a stop order this way, so that it can be easily activated by normal market movements.
As soon as we have a stop order level. we will know our risk. For example, if we know, that the size of the stop order is 50 pips for a currency pair (or. for example. 50 cents for a stock or commodity futures) from the market entry price, then we can start sizing our position. Next moment, which we must consider – this is the size of our trading account. We shouldn't risk it anymore 1%-3% from our account in every trade. Account percentage, which we are ready to risk, often misinterpreted, that's why, let's consider the following scenario:
Suppose, that the trader has a trading account in 5 000$. If a trader takes risks 1% your trading account in a deal, then it means, that a trader can lose 50S on one trade, from which follows, that he can only afford one mini-lot for the transaction described above (for example, for the EURUSD or GBPUSD currency pair) If the stop order level is reached, then the trader will lose 50 pips on one mini-lot or 50S. If the trader uses a 3% risk level, then he may lose 150S (what constitutes 3% on the value of his account), meaning, that at a stop order level of 50 points, he can take 3 mini-lot If a stop order is triggered. trader will lose 50 points on 3 mini-lotah, or 150$.
In the stock market, risk in 1 % from your account on one trade would mean taking 100 stocks with a stop order level of 50 cents If the stop order had been reached, then this would mean the loss of 50S or 1% of the total trading account on one deal. The risk on the transaction should be a small percentage of the account, and the position size must be adjusted for this risk.
Alternative methods
For large accounts, there are some alternative options for sizing positions, which can also be used by private traders. For example, traders, having on the trading account 500.000$-1 000 000$. may not want to risk 5 000$ or more (1% from 500.0005) on every deal. They have many positions in the market, and may not actually use all of their trading capital, or there may be liquidity problems for large positions. That's why, in this case a stop order with a fixed dollar value can be used. Let's say, such a trader prefers to take risks only 1.000$ on one deal. They can still use the method, mentioned above. Suppose 1.000$ – this is their selected maximum loss on the trade (less 1% from trading account) If the value of the stop order from the entry price is 50 points, then they can take 20 mini lots, or 2 standard lots.
In the stock market, they could take 2.000 stocks with a stop order of 50 cents from entry price. If the stop order is reached, then the trader will only lose 1.000$ -maximum allowable loss, initially defined.
Daily loss levels
Another option for active traders, trading full time, is to use the level of daily losses. Levels of daily losses allow traders to quickly make decisions on the size of trading positions. Daily loss levels mean, that the trader sets the maximum loss for one day (week or month). If he loses this predetermined amount of capital, then it immediately exits all positions and stops trading the rest of the day (weeks or months). Trader, using this method, must have a history of positive transactions.
Experienced traders day, the daily loss level can be approximately equal to their average daily profit For example. if the average trader makes $ 1,000 / day, then he should set the daily loss level, approximately equal to this value. That means, that a losing day wont destroy profits anymore, in less than one average trading day. This method can also be adapted, to reflect the results of several days (weeks or months) Trade.
For traders, who have a history of good deals, or who practices extremely active trading during the day. daily loss level provides flexibility in deciding on the size of positions throughout the day, and at the same time allows you to control their overall risk. Most traders, using daily loss rates will still limit their risk to a very small percentage of their account on each trade, determining the size of open positions and controlling the risk of your trading account.
The novice trader with a short trading history can also apply the daily loss method in conjunction with the use of proper position sizing – determined by the risk of the transaction and the total balance of the trading account.
Conclusion
Determining the proper position sizing before entering the actual trade can have a very positive impact on trading results.. Position size is adjusted in this way, to ward off the risk, involved in a deal. To establish the correct position sizing, we must first know our stop placement level and propene (or the value in dollars) from our account, which we are ready to risk in one deal. Once we have identified them, we can calculate the ideal position sizing.
