Forex Position Sizing (Money Management) - The KEY to Successful Forex Trading
It's not your winning percentage % but instead the ratio of how much BIGGER your wins are vs losses!
One of the most important things we've observed over the years by watching thousands of traders trade and seeing their results is that successful traders RISK a small percentage of their accounts on any ONE trade. They do not risk more than 1-3% per trade and tend to FOCUS more on finding trades that are more likely to be big winners than worry if trade will work or not. In our opinion, traders that focus too much on having a high winning percentage tend to be novice, inexperienced losing traders. Having LOSSES is a part of trading and THE KEY seems to be trying to offset losses by having big winning trades.
Again to summarize, it's our belief that the key to trading Forex markets successfully is having small losses and LARGE wins.
How do you prevent yourself from suffering big losses?
First, BEFORE YOU PLACE THE TRADE you should KNOW WHERE YOU WILL EXIT IF WRONG. This should be an area that is highly likely to mean the trade won't recover and thus a good place to exit with SMALL LOSS vs risking more money hoping the trade reverses.
Novice traders HOPE while professional traders recognize when a trade isn't working and bail and feel almost no stress in doing so.
It's just a numbers game!
How do you know where to place Forex Stop Loss?
We typically use the previous swing's low for buys and high for sells plus a couple of pips padding so that market noise doesn't knock you out and cause you to miss a profitable move. You may also use the next closest Support or Resistance area or use the markets current volatility by using one of our many Intelligent Trailing Stops.
With our Forex Software , my partner and I have created a currency meter to measure all the currencies and we FOCUS on buying the strongest one(s) vs weakest and selling the weakest one(s) vs strongest. In our opinion this allows you to find more trades and since currency momentum is high if the trade does continue trending it tends to move more pips than what you're risking. Most of our systems have 6-12 pip average losses.
The next step is to determine how much in % terms you are willing to risk per trade.
Risking 1 to 2% Per Trade is a good base line
Position Sizing Example #1
Our Forex Software has advanced position sizing built in. In this example a trader has a $2,000 account and wants to risk 2% on a trade which is $40, and by setting the Maximum Stop loss to 10 pips and putting in 1 for an all in position (no scale in) it spits out .4 Mini Lot is the correct position size to trade in this situation.
Advanced Traders Only
If you wish to try to buy the low but are not sure which support area will hold but really believe trade will reverse our position sizer lets you scale in however you like. You could, for example, buy 1 lot then 15 pips lower buy 1 more lot OR buy 1 lot and 15 pips lower buy 2 lots and 30 pips lower buy 30 lots. (Progressive Scaling). This is VERY DANGEROUS in the hands of new and inexperienced traders but if done in a manner where the Maximum Trade Loss % of Account is small (2-4%) can be done every once in awhile to catch a reversal.
Our currency software also shows you how much the Average Price Moved so you know ahead of time where your break even is. You can devise a scale in method that may let you exit at break even a trade when it moves only 5-10 pips. I'll show that example below.
Position Sizing (Scale In) Example #2
In this example a trader has a $10,000 account and wants to risk 2% on a trade which is $200, but isn't sure where market will reverse but they're confident it will. They decide they want to buy, then buy a 2X bigger sized position 15 pips down and a 3X sized position 25 pips down. Their stop loss is wide at 40 pips but they are still risking only 2% on this trade.
Break Even is only 7.36 pips away from last entry.
In this example a trader can buy with .14 lots, then .29 lots when it goes 15 pips down and finally .44 lots 25 pips down. Even though position is 25 pips away from first entry by progressively scaling in break even gets yanked down 17.64 pips (7.36 pips away from last price).
ADVANCED TRADERS ONLY (Varrying Risk % Based on Trade Probability!)
If you are a profitable and experienced trader, you will likely have varied trading styles, methods, and strategies. Some may succeed 50% of the time, while others don't occur too often, but are extremely successful when they do. For advanced traders only, I recommend they risk more on the trades that are likely to succeed that also often have much bigger pip gains than other systems.
So, for instance, if your normal systems win 40 to 60 percent of the time, but one only finds a few trades per week but is usually 80% winning and gives you giant wins, say 30 to 50+ pips on average, I recommend you INCREASE the % Risk and Size of your trade. I will increase the size on my trades 30 to 100%. This can have dramatic impact on your AVG WIN size, which I'll explain later, along with how it impacts your NET PROFITABILITY!
Now, this is only the beginning. In order to be profitable, your wins should be 50% larger than your losses.
This means that if on average you lose $100 on your losses, you should be making $150 on average for your winning trades. By examining my personal experiences and watching the accounts of my close to 3,500 traders, I've found that big wins (30-50+ pips) only happen 10 to 20% of the time for good traders. This means that other times our wins are 5, 10, 15, or 20 pips. The huge 30-50+ pip wins just expand the size of our average winning trade.
Never take trades that are likely to make LESS THAN YOUR RISK. This is a recipe for disaster and should be avoided at all costs.
The profitability formula is:
(Number of trades) X (Winning Percentage) X (Average Win Amount) MINUS
(Number of trades) X (Losing Percentage) X (Average Loss Amount)
Looking at the formula above you should be able to see many ways to improve your Forex Trading. Increase winning percentage, increase Average Win Size by trying to get more pips in some trades and locking in profits on others as it goes your way. Reducing your average loss amount is also KEY and can be accomplished by moving stop loss in half once currency goes 6-12 pips your way or moving it to break even when currency goes 10-15 pips your way. You can also use a trailing stop to reduce your average losing amount because most of the systems we teach have you enter trade when price starts moving and this automatically tightens the stop and has you many times losing LESS than the original stop loss amount.
Moving your stop loss as mentioned above can reduce your winning percentage however it also drastically reduces your average loss. It's one of the secrets to Forex Trading that is rarely mentioned in books.
If you take 5 or 6 trades per day by just eliminating one losing trade each day can have a profound impact on your Forex Trading success.