Position sizing

Start from the loss, not the position

Most new traders decide how many lots to trade by looking at what the margin allows, and then find out afterwards what a losing trade cost. Position sizing reverses the order. First decide how much of the account a single losing trade may cost, commonly one or two percent. Then decide where the stop loss goes, in pips, on the basis of the chart rather than the money. Only then work out the position size that makes those two numbers agree.

The method

The size is the risk amount divided by the loss per lot if the stop is hit, and the loss per lot is the stop distance in pips times the pip value per lot in the account currency.

Take a 10,000 dollar account, one percent risk and a trade on EUR/USD with a 25 pip stop. The risk amount is 100 dollars. One pip on a standard lot of EUR/USD is 10 dollars, so a 25 pip stop costs 250 dollars per lot. The size is 100 divided by 250, or 0.40 lots. If the stop is hit the account loses 100 dollars, which is what was decided. If the stop were 50 pips the size would be 0.20 lots, and the loss would still be 100 dollars.

The position size calculator does this for any pair, account currency and stop, and it is worth using until the arithmetic is second nature.

Why a fixed percentage

Risking a fixed share of the account rather than a fixed amount means the size falls as the account shrinks and rises as it grows. After a run of losses the trader is automatically trading smaller, which is the moment it matters most. It also makes a long run of losses survivable: twenty consecutive one-percent losses leave 82 percent of the account, which is painful but recoverable, whereas twenty losses at five percent leave 36 percent.

What it prevents

Sizing by risk removes the two ways retail accounts usually end. It stops the single oversized trade, because the size is bounded by the risk whatever the leverage on offer. And it stops the slow bleed of trades that were each a little too large, because every trade costs the same share of the account when it fails. It does not make trades win more often; it makes the losing ones affordable.

Practical points

Include the spread in the stop distance, because the position starts the spread's width in loss. Check that the size the calculator gives is one the broker allows, since minimum sizes and step sizes vary. Be aware that a stop is not a guarantee, because a market can gap through it, which the stop loss article covers. And treat the risk percentage as a maximum rather than a target; there is no rule that every trade must risk the full amount.