Having a proper calculated position size and Stop Loss will help you build your account, but most importantly it will help you protect your Trading Capital.
If you can master the Art of Money Management, then you will have more chance of survival in this trading game, even if your trading system isn't one of the best.
Lots of new traders have no clue about what a proper stop and position size is; lots of them risk way to much money on each trade, leaving them with an empty account and lots of fear and disappointment.
Before making a decision on how big your stop and position size should be, you need to decide which % of your capital you are willing to risk per trade.
The percentage risk is different for each trader as not everyone's risk appetite is the same. However, it wouldn't be very wise to risk more then a maximum of 2% of your trading capital per trade, especially if you are new to trading.
The less risk you take, the more room you have for losses. For example, if you use a 2% risk per trade, than you would be able to take
50 losses in a row before blowing your whole trading capital away.
But if you take a 0.5% risk per trade, than you will be able to take 200 losses in a row, in case things would go bad, offering you much more room for losses... Of course we hope that you won't take 200 losses in a row, we just want to show you the different possibilities.
Once you have chosen how much % you can stomach risking per trade, you can now calculate how many lots you are going to trade; your position size.
What is a position size?
A position size simply determines the amount of money you want to trade per pip. In forex, the pip value is calculated in "lots." A standard lot is 100,000 units, a mini lot is 10,000 units, a micro lot is 1,000 units and a nano lot is 100 units.
For example 1 standard lot which is 100,000 units, on the EURUSD is worth $10. Every currency pair with US Dollar as the Quote Currency (XXX/USD), will have the same pip value. However every other instrument that is quoted with the US dollar first will be have to be calculated in a different way.This is why the pip value is different for many of the pairs we trade.
A simple way to calculate the pip value is to multiply 1 pip with the lot value.
Example:
EURUSD (1 pip) 0,0001 x 100,000 units = $10 for 1 standard lot
0,0001 x 10,000 units = $ 1 for 1 mini lot
0,0001 x 1,000 units = $ 0,10 for 1 micro lot
0,0001 x 100 units = $ 0,01 for 1 nano lot
USDCHF (1 pip) 0,0001 x 100,000 units = SFr10 for 1 standard lot
0,0001 x 10,000 units = SFr 1 for 1 mini lot
0,0001 x 1,000 units = SFr 0,10 for 1 micro lot
0,0001 x 100 units = SFr 0,01 for 1 nano lot
Commodities, CFD's, Futures, Indices etc will each have their own pip values also.
Attention!!!
The Pip Value per lot can differ greatly from instrument to instrument!
In order to calculate your position size, you first have to know how far from entry your stop loss is. For example, If you have a $10,000 US account and you are only wanting to risk 1% of your trading capital, then you can risk $100 US per trade. In other words, if you would trade the EURUSD with 1 standard lot ($10 US) than you would allow price to go against you by maximum 10 pips. 10 pips x $10 US = $100 US.
Or you could trade with a mini lot ($1 US) (on the EURUSD) this way, you could use a 100 pips Stop Loss. 100 pips x $1 US = $100 US
What is a Stop Loss?
It is possible to limit your losses and protect your trading capital in forex by placing a "Stop Loss" order.
It's simply a pending order at a certain price, selling to cancel your buys, or buying to cancel your sells.
Choosing your stop loss allows you to calculate your position size, by dividing how much you're prepared to risk by how many pips your SL is from your entry.
Your technical analysis will tell you where your SL should be.
Let's now calculate a risk percentage, a position size and a Stop Loss... Let's say that your trading capital is $10,000 US and that you are willing to risk 1% of it on every trade.
Based on 1% risk, (looking at the worst case scenario) you would be able to take 100 losses in a row.
Now, say your technical analysis tells you that you need a 25 pips Stop Loss for a particular trade, then you would calculate your position size as follows.
1% of $10,000 US = $100 US
$100 divided by 25 pips Stop Loss = $4
So if you have a $10,000 US account and you are willing to take a 25 pip Stop Loss, then your Pip Value should be $4 US.
Knowing the pip value per lot on the pair, you can calculate how many lots you should trade
*Pip Value: The amount of money per pip movement
Let's say that you want to place a Buy Order on the EURUSD at 1.2500, if we take the above example than your Stop Loss would be at 1.2475.
1.2500-25 pips Stop Loss = 1.2475
If your Stop Loss would have been hit, then you would have lost 25 pips x $4 = $100 US
Article Source: http://EzineArticles.com/?expert=Mel_Al
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