Risk Management 101

08 - Proper Position Sizing


As discussed in the previous section, the use of an equity stop and a chart stop can be combined to calculate position sizes for each trade. Many beginner traders make the mistake of setting the position size first before determining the stop loss in pips, which can lead them to neglect price action.

Proper position sizing allows the trader to have just the right number of lots based on how much of the account he or she is willing to risk per trade and on the size of the stop based on past price action and volatility.

In order to calculate the right position size for each trade, one needs the following inputs: account balance, pip value of the pair you are trading, percentage of your account balance that you are willing to risk, and the stop loss in pips.

The calculation is simple when your account is denominated in the same currency as the counter currency of the pair you are trading. For example, this means having your account denominated in dollars when trading EUR/USD or GBP/USD. The calculation is also simpler if you have a GBP-denominated account and you are trading EUR/GBP.

In this case, you simply have to calculate the monetary value of your risk on the trade, based on the percentage risk and your current account balance. If you have a $10,000 account and you'd like to risk 1%, then the monetary value of your risk is $100.

From there, you divide the amount risked by the number of pips. If you are trading EUR/USD with a hundred-pip stop, then the amount risked per pip is $100 divided by 100 pips or $1/pip. After getting this figure, you then multiply it by the unit-to-pip value of the currency pair you are trading to get the position size.

There are additional steps involved when your account currency is different from the counter currency. However, you can always make use of pip value or position size calculators available on most trading platforms or educational websites.

What's important is that you use the percentage risk and chart stop as inputs to generate the position size and not the other way around. It takes practice to stick to this risk management habit and discipline to execute it regularly.