ForexNewsNow – Position sizing refers to the process by which traders determine how much risk to take on. This risk management procedure typically takes place once they have already decided to establish a position in their online trading account and know what direction to position themselves in.
Although some very simple position sizing techniques can be useful to novice traders, the best forex trader risk management strategies for position sizing tend to take such things as portfolio size, estimated risk/reward ratios and trade success probabilities into account. The following sections will discuss these position sizing techniques in greater detail.
Fixed Position Sizing
Perhaps the simplest form of position sizing used by many traders when they first open up their online trading account is to only make transactions in a fixed position size. Most of the top forex brokers support popular minimum transaction amounts of standard, mini and micro lots to accommodate different traders’ position size preferences.
For a larger trader with deeper pockets, their fixed position size might be a standard lot of 100,000 base currency units, while an intermediate trader with a smaller portfolio might deal in a fixed position size of mini lots of 10,000 base currency units.
Nevertheless, a novice trader with less risk capital to speculate with and who wishes to practice trading before putting more money at risk, might use a fixed position size that involves trading in only single micro lots of 1,000 base currency units.
Scaling Position Size to Portfolio Size
Another popular position sizing technique that can be implemented in an online trading account involves changing the standard position size traded as your portfolio grows or shrinks in size.
Using this position sizing technique, if you have traded profitably recently and your portfolio size has increased to reflect that success, then you might consider increasing your position size proportionately.
On the other hand, if a series of losing trades have recently reduced your portfolio’s value, this might indicate that your standard position size should be reduced in order to help conserve your trading capital while you improve your trading strategy.
Using the Risk Reward Ratio to Size Positions
A more sophisticated form of position sizing uses the risk reward ratio to scale positions. This typically involves estimating the potential risk and potential reward associated with a particular trade and then computing the ratio of the two. Furthermore, most of the best forex trader strategies will only establish positions if the estimated risk/reward ratio is 1:2 or greater.
For instance, a trader using a position sizing technique involving the risk/reward ratio for a trade with an estimated 1:2 risk/reward ratio might take on a trade of two lots in their online trading account, while they might trade three lots for a trade with a 1:3 risk/reward ratio, four lots for a trade with a 1:4 risk/reward ratio, and so on.
Position Sizing Using Probability Weighting
Some traders prefer to employ a position sizing technique that utilizes probability weights. This means that the more successful they think a trade is likely to be, the greater will be the position size established in their online trading account.
Although most forms of probability weighting tend to be rather subjective, this position sizing method can still help a trader make higher gains from trades that they feel especially strongly about taking, while reducing their exposure to trades that they are less certain about.