How to decide on a proper forex position size.
A successful traders strength to make money is sometimes misinterpreted with the fact that most trades are going to workout. In fact, an abundance of successful traders experience loses frequently.
Successful traders know that money management is an essential attribute of forex trading.
If this is the case, why don’t more traders establish a concrete money management plan?
The key to become consistently profitable lies in the solution of money management and your forex position sizing strategy.
A prevailing method: The Elder Method
Dr Alexander Elder, born in St petersburg, Russia and raised in Estonia wrote an influential book “Come into my trading room” in which he states:
A money management (position size) should be based on 2% of trading capital available. You can determine your entry price and your stop loss level. The difference between these two prices is your risk per trade. You can then calculate how much you can risk as long as it is not more than 2% of your total trading account balance.
This means that with 10 continuous losses you will only decrease 20% of your capital.
There are however detractors to this method:
Many traders claim that if you start with $10,000 and your drawn down is $5,000 while using a fixed percentage method, it will take you more time to regain the lost amount because you began risking 2% per trade which was $200, but at the $5,000 draw-down point, your only risking $100 per trade, so even if you have a good winning streak, your capital is recovering at half the rate.
The leverage concern.
Leverage is the ability to obtain a large amount of money using a small, disproportionate amount of your own money and borrowing the rest.
Leverage is capable of increasing your profits, but can be catastrophic if not used correctly because it can quickly deplete your account.
Margin
Margin is the amount of money needed to be deposited by your broker so that a position can be opened in a trade.
In forex, to control a $100,000 position, your broker will set aside $1,000 from your account. Your leverage, which is expressed in ratios, is now 100:1. You’re now controlling $100,000 with $1,000
Risk too much on each trade, and you can deplete your account in a hurry with just a few losing trades. Risk too little and your account won’t grow. Use the formula to make sure you have the ideal position size for your account size and the trade you’re taking.
Simple rules to follow for forex position sizing
- Cut your losing trades short.
- Let your winning trades run.
- Never risk too much on a single trade.
- Size your positions according to the volatility of what you are trading.
Whatever the case maybe, understanding forex position size, money management, and leverage function is one of the major keys that will take your trading to the next level.
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