In forex trading, position sizing is the number of units that are invested in a particular security by a forex broker or an investor. Furthermore, the account size and risk tolerance should be considered when determining the right position sizing.
Understanding Position Sizing
The size of the position in a specific portfolio is the position sizing, to make this simple, it is the amount of money that you are going to trade. Forex brokers utilize position sizing to let them determine the number of units of security they can buy and this helps them in controlling their risks and maximize the profits they gain.
Position sizing helps you determine the right amount of units to sell or buy in a forex pair. It is considered as one of the key elements in risk management, this also helps you know whether you’ll be able to trade another day or not. This keeps you from taking too many risks on making your trades that may lead to you blowing up your account. In trading, it is true that when a forex broker makes a huge bet, he can also win huge. However, what happens when it goes the other way around and he loses? Of course, he loses huge too.
Importance of Position Sizing
Let’s put it this way, suppose you had $30,000 to trade and you’re confident that stock XYZ which is currently priced at $10 is getting higher. Now, you make a decision to buy 2,000 shares which costs you $20,000. Your profits come out the following week but the stock has dropped to $9 and continuously declines the next week which finally settled to $5. Then, this made you realize that you made the wrong decision and close out the position, making you lose $10,000 in just a matter of a few weeks.
You see, the problem in that trade was the position sizing which is 2,000 shares is quite random compared to a well-planned one that is calibrated to the account size.
Calculating Position Sizing
Whenever you calculate your position sizing, you must first determine and acknowledge your account’s risk profile. So, if you see yourself thinking of making a huge bet on a specific trade, you should first ask yourself the main reason why you are about to do so. Because clearly, you shouldn’t just make a trade on something just because you feel like it. A forex broker can always find himself trading too much on his setups even when he knows that he shouldn’t because of his past experiences. Why does he keep on doing this?
You see, most of the time, it boils down to not just greed, but also self-worth. In addition, some forex brokers make huge bets in hopes of winning huge in return.
The problem with this though is that these brokers don’t understand that they could lose as much and they would soon find themselves not having control over their emotions when prices go against their way. Therefore, to address this problem, you should always take position sizing into consideration.