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Lesson 3 What is Position Sizing in Forex (Part Three)?

Lesson 3 What is Position Sizing in Forex (Part Three)?

Reading Time: 5 Minutes

Following on from parts 1 and 2—articles dedicated to position size calculation techniques for accounts denominated in the same currency as either the currency pair’s (Forex pair) term currency or base currency—the final part of this position sizing journey centres on position size calculation for account currencies possessing no association with the currency pair of interest.

As a reminder, position sizing is a combination of risk management and money management.

How to Calculate Position Size?

Position size calculation with accounts denominated in the same currency as the currency pair’s conversion base currency.

The difference from position size formulas in parts 1 and 2 is a conversion currency pair is necessary to express the size of a trader’s position:

Formula:

(Trade Risk * Conversion Exchange Rate) / Stop Distance

Imagine a 10,000 GBP (British pounds) trading account, with the trader content with risking 3 per cent of account equity on this single trade (300 GBP). This can be referred to as either ‘account risk’ or ‘trade risk’, which often changes depending on the account size (for example, a 9,000 GBP account balance risking 3 per cent is 270 GBP). The currency pair of interest is EUR/USD (euro against the US dollar) with a protective stop-loss level arranged 30 pips from the entry price. Trading strategies using small stop-loss orders generally fall under the umbrella of either ‘day trading’ (day traders) or ‘scalping’ trading styles.

ID: 153699737

Because currency pairs are priced through their term currencies, the trader is unable to use the EUR/USD as the account currency is not the same as either the base or term currency. It’s important to remember that the trader must calculate the dollar amount of 300 GBP, not the dollar amount in euro. This can be achieved through the GBP/USD exchange rate: $1.2544, which shows 1 GBP priced at $1.2544.

Knowing 1 GBP is priced at $1.2544, and the trader wants to understand how much 300 GBP is valued in US dollar, the trader can multiply 300 GBP by $1.2544

376.32 USD = 300 GBP * $1.2544.

Once USD trade risk is found, the formula is the same for an account currency matching the term currency in a currency pair: divide trade risk by stop-loss distance:

125,440 units (euro) = (300 * $1.2544) / 0.0030

125,440 units limits risk to 300 GBP: a 1.26 lot size can be entered in MetaTrader’s order window for 1 standard lot, 2 mini lots and 6 micro lots (rounded up) or 1.25 (rounded down).

When the account currency matches the currency pair’s conversion term currency?

Assume the same trader opens a new account and deposits 10,000 USD. Adopting a more risk-averse approach this time, the trader is only willing to risk 1 per cent of their account equity on the trade (100 USD). The currency pair of interest is the GBP/AUD and the protective stop-loss order is set 50 pips from the entry point. Trading systems using large stop losses—such as 50 pips—mean the trader generally follows a swing trading style.

The first step to calculating position size involves understanding AUD risk; this is the term currency in the selected currency pair (GBP/AUD). For this, the AUD/USD exchange rate ($0.7202) is used. But to discover AUD risk, the next step involves inverting AUD/USD to convert the currency pair to USD/AUD. This is achieved by dividing 1 by the exchange rate (1 / $0.7202) to reach AU$1.3885.

ID 619015802

Following the formula above:

27,770 units (GBP) = (100 USD * Inverted Exchange Rate AU$1.3885 / 0.0050

In the MetaTrader order window, the trader can use 0.28 (rounded up) or 0.27 (rounded down) to maintain the desired risk limit on the trade: 100 USD. This is essentially 2 mini lots and 8 (7) micro lots.

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