Choosing your position size and stop loss correctly, for each trade you enter, are very important factors in trading the Forex Market successfully. Failure to do so is probably the core reason why so many traders lose, as it often leads to overtrading i.e. using position sizes that are too large a proportion of the trader’s account.

To help protect yourself from this problem, you could utilize a money management strategy that states that your position size, for every trade entered, should always be based on the maximum percentage of your account that you are willing to risk. As a general rule, you should not risk more than about 2% on a single trade.

For example, if you have $5000 in your account, you should not risk more than $100 on each trade.

When trading, the risk per trade depends on position size and stop loss. Your position-size is the amount of a currency that you intend to buy or sell and is measured in lots. Your stop loss determines how far you are willing to let a trade go against you before you exit and take a loss. Stop loss is measured in PIPs.

The PIP is a very important unit of measurement that you need to understand in order to control your profit targets and potential losses. Of paramount importance is that you must determine how much one pip movement will affect your account balance for every trade you enter.

PIP_Value = Lot_Size X Tick_Size

Example: Standard lot of GBP/USD
Lot_Size =100,000
Tick_Size = 0.0001

1 pip = 100,000 X .0001 = $10.00 USD

You should always know your stop loss value before you calculate your position-size and enter a trade.

For example, let’s say you are about to enter a trade with a stop loss of 100 pips. Let’s assume you have an account balance of $100,000 USD. You want to know how many lots you should trade of GBPUSD (with pip value = $10) so that you are only risking 2% of your account. You can calculate your position-size as follows:

Position Size = (%Risk X Free_Margin) / ((PIP_Value X Stop_Loss))

Position Size = (0.02 X $100,000) / ($10.00 X 100)
Position Size = $2000 / $1,000
Position Size = 2 lots

In summary, the above example shows that the position-size you should trade, whilst risking only 2% of your account with a stop loss of 100 pips, is 2 lots. Consequently, you can now enter your trade with confidence knowing, that should it turn against you, your total loss will only represent 2% of your account.

The key to successful trading is the preservation of your bankroll because without it you cannot play anymore. This is why the careful calculations of your position size and stop loss for every trade entered are so important.

There are a number of types of stops that have different advantages and disadvantages:

Equity Stop can be used to close trades if the total balance of an account drops below a pre-determine limit i.e. 2%. This stop strategy has the advantage of strict account control but tends to be inflexible because valid trades can be closed as a result of random price spikes.

Chart Stop allow you to place stops at key places on charts such as pivot points or Fibonacci retracement levels. These stops are flexible because they can cope well with Forex market features such as volatility. However if you change the position of the stop loss during the life of the trade, to follow new patterns emerging on the chart, than you should take care to only move the stop loss so that it is closer to the current market price. If you move the stop loss further away from the price, in other words if you increase the stop loss, than you might incur larger losses as a result.

Volatility Stops are intended not to respond to normal price fluctuations and are triggered only by large increases in market activity such as volatility surges. In other words, you will not be taken out of your trade because of minor market moves. Only if the market moves sharply in the opposite direction of your trade, you will be taken out. As such, this type of stop can be useful to control losses whilst market conditions are calm but could entail undesirable degrees of risk otherwise.

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