To calculate position size based on risk tolerance see our Position Size and Risk Calculator.
An effective money management strategy involves what is known as “position sizing,” which as the name implies consists of determining what size position you are going to take on a particular trade.
Position sizing can be performed in a number of ways form the simple to the complex. The best rule of thumb in making a choice between them is to choose the one that works best with your system. As we have learned in the previous sections, what we want in a good position sizing technique is to be able to easily handle the losing trades so that we can continue to trade the winning trades and have a profitable system.
Let us have a look at three position sizing models:
1) Fixed Lot Size
Excellent for newbies, fixed position sizing means that the trader will trade with the same position size, preferably a small one. He may change the lot size at different intervals as the account increases or decreases.
What size position is preferred for the account size?
It all depends on the account size, of course, but the rule of thumb is to keep your trade size as small as possible, preferably at 2:1 leverage or less:
Example #1: $5000 Mini Account
At 2:1 leverage per trade, start with 1 mini lot
(reason: 1 mini lot is 10000 units, and thus 2 times greater than account size)
Example #2: $500 Micro Account
At 2:1 leverage per trade, start with 1 micro lot
(reason: 1 micro lot is 1000 units, and thus 2 times greater than account size)
2) Equity Percent
This method has you determine the size of your position based on percentage changes in equity. You specify the percentage of equity that each position should take. The method can allow for geometric growth of equity because the size of the position grows in relation to the equity growth of the account. Though you can trade more aggressively with an increase in % of equity, you should always remember that the larger the percentage, the more potential profit as well as potential risk.
What percent of equity should one trade with?
It is usually safer to trade with a smaller percentage of equity, such as 1% or 2%. For example: if you trade with 2% of Equity, which equates to using 2:1 leverage per trade, it will allow you to stay in the game longer. However, if you are to trade more than 1 system in the same account, I will trade with 1% of equity, which equates to using 1:1 leverage per trade (no leverage).
The Equity(%) formula is:
Here is a $7,000 account wanting to trade with 2% Risk:
Here is a simple formula coded up in MQ4:
double vLots = NormalizeDouble(AccountEquity() * (Risk/100) / 10000 *100, LotDigits);return(vLots);
3) Advanced Equity Percent With Stop Loss (Fixed Fractional)
The idea behind fixed fractional position sizing is that the number of units you trade with is based on your pre-determined percentage risk per trade and your stop loss distance. The risk is the same percentage of account equity on each trade and is related to your changing equity and stop loss size.
How does one calculate the % risk per trade and the stop loss amount in order to derive the lot size?
Let us break it down in three steps:
- Calculate your % loss comfort level per trade. You need to be comfortable losing on any one trade because you can lose on many of them. Generally, you should anticipate losing on 10 consecutive losing trades and try not to exceed a 25% drawdown, which means that you should consider risking only 2% on each in order to survive a 10 trade losing streak.
- Determine your stop loss level. Generally, will have optimized and back-tested your system to determine the appropriate stop level. You should never place your stop too close to your entry in order to trade higher lot size.
- Determine your lot size based on % risk and stop loss level. You need to determine the number of mini or micro lots to trade that will give you the % risk you want with the stop distance you have decided is most logical to your system. For instance, since one micro lot is $1 per pip, and you have a pre-defined risk of 2% of a $10,000 account ($200), and your stop loss distance 50 pips, you will trade 4 mini lots ($4 per pip x 50 pip stop loss = $200 risked.
Furthermore, you should be following two rules:
- Rule #1: You should never adjust your stop loss to meet your desired position size; instead you always adjust your position size to meet your pre-defined risk and logical stop placement.
- Rule #2: You will be trading the same risk on every trade, though the lot size may vary depending on the stop loss size. If you have a wider stop you don’t risk more money on it and if you have a narrow stop you don’t risk less. Instead, you are adjusting your position to meet your pre-determined risk amount, not risking more or less.
The fixed fractional formula is:
Let us use the above equation to solve this $5000 mini account scenario:
Let us use the above equation to solve this $300 account with 30 pip stop loss:
Here is a simple formula coded up in MQ4:
extern double StopLoss = 30; //Custom Function, Lots()
double vLots = NormalizeDouble(AccountEquity() * (Risk/100) / StopLoss * 10 / 100, LotDigits);return(vLots);
Tools to Calculate Fixed Fractional Position Size
Online Fixed Fractional Calculators:
A good calculator to help you determine your position sizing relative to your ideal percentage risk per trade can be found here: Position Size Calculator
|PositionSize||Set the % risk level desired, and just drag the indicator to your chart to print out on screen appropriate lot sizes for different stop amounts.|
What technique to use? Choose the technique that maximizes your chances of survival and success. First, you have to survive, and that means you have to control risk.
Second, you need to figure out your position size.
If you are using a good trend following system which nevertheless produces large Drawdowns from time to time, your first objective should be survival and so you should choose the best technique to achieve that.
If, however, you have a highly reliable system which doesn’t produce either big Drawdowns or big profits, you should concentrate on maximizing those small profits. Remember that the wrong money management applied to your system could actually hurt the end result.
Just as there are no “Holy Grail” trading systems, there is no “one-size-fits-all” money management approach. Each trading system requires a certain money management technique and each technique may be valid for one trader and be useless for another. In addition, the trader’s ability to test and implement that money management strategy has to be considered. The key when choosing a money management model is often self-understanding.
Sizing and managing market positions are often seen as a burdensome, unpleasant activity. And unfortunately, most traders can only absorb the lessons of risk discipline through the harsh experience of monetary loss.
Many times, traditional advice such as making sure your profit is more than your loss per absolute trade does not have much substantial value in the real trading world compared to the great potential of a sound money management technique.