Entering a trade can be a nerve-wracking experience.
But it doesn't have to be.
Part of making it less stressful is using the optimal Forex position sizing. If you know exactly how many lots you should trade, that is one less thing that you have to worry about.
Optimal Forex lot size and consistent use of the same risk per trade will also allow you to make way more money in the long-run.
Even if you have been trading for awhile, how do you know that your entry strategy is optimal. Could you improve it, simply by adjusting the position sizing?
That is what I'm going to show you in this blog post. Here are the three simple steps to figure out what position size will work best for you.
1. How Much Should I Risk Per Trade?
Before you get too deep into different entry strategies and position sizing, it is first important to understand how much you should be risking on each trade. There are two components to this.
Games Help You Learn Faster
First, you need to understand the optimal risk per trade. A great way to understand this is by using the Van Tharp position sizing game.
Walter turned me on to this and I agree with him in that this should be required training for any new trader. It took me a couple of tries to get the hang of it, but I was eventually able to run up the account to over $14,000,000,000!
Yes, with a “B!”
Here's a screenshot…
So how did I do it?
I won't spoil the fun, you will just have to figure it out for yourself. 🙂
But I can show you why the game is such a great teaching tool. For starters, games are a great way to learn basic concepts, in a fun and low pressure environment.
When you are relaxed, you get lost in trying to win the game and sometimes forget that you are learning something. One of my favorite games is Cashflow by Robert Kiyosaki.
I didn't think that it could teach me anything. But it was surprisingly good at teaching some complex concepts in a way that was easy to understand.
Position Sizing Game Overview
Anyway, back to the Van Tharp position sizing game…
A warning beforehand…this program is old school. Not Ed-Sykota-punch-cards old school.
But late 1990's, dot-com crash, old school.
So it only runs on Windows.
…and it still uses “puffy” fonts. It reminds me of the first website I built.
After you get past the splash screen, the main account window pops up. It took me some time to get used to using it.
But if you read the directions, it starts to make sense. Not the greatest interface.
From there, you have a starting account balance of $10,o00 and you have to pass 10 levels to win the game.
In order to pass a level, you have to make a certain amount of money within 75 trades.
Sounds simple enough. But as you progress, the levels get harder and harder.
The interesting thing is that different levels introduce different variables into the mix.
Here are the main ones:
- The option to go long and short
- A price chart
- Name and price of the stock
- Amount you have to make per level
- The ability to move your stop loss
It can be easy to get tripped up with these things changing between levels, but that is the beauty of the game. You will learn that a lot of these things actually don't matter.
Yes, it sounds weird, but the game teaches you what really matters in trading (besides psychology).
It is a little pricey at $199, but I think it is totally worth it. It is especially valuable if you are just getting started in trading or have blown out a live account recently.
You can try the first three levels for free though. So I highly recommend that you at least try that.
A fun element of the game is when the voice of Van Tharp actually comes on at certain points in the game.
Look out for it!
Here's a great video that shows you the value of using the right position sizing strategies.
2. Gut Check Your Risk Level
Once you understand how much of your trading account you “should be” risking per trade, now you need to see if your stomach can actually handle risking that much per trade. The best way to do this is to open a small account that allows you to trade nano lots.
Wait…
Before you do that, you do have a trading strategy, that you have tested…right? If not review this guide and this guide to learn to test a trading strategy and make sure that it has a very good chance of succeeding.
OK, if you have that taken care of, then you can proceed…
When doing your gut check, you will be surprised at the effect that even losing a small amount of money can have on your psychology. At this point, you are not trying to make money.
Your goal is to figure out how much you are comfortable losing on each trade. If you have any doubts, I suggest trying different risk amounts from 0.5% to 2%, in 0.5% increments.
Once you do about 100 trades or so, you should understand your risk tolerance level. That number of trades usually does the trick. But if not, then keep going until you feel comfortable with a certain amount, or at least a small range.
Now, there are some traders out there that will think that they are comfortable with risking more than 2% or even more than 5%.
These are the cowboys.
…and we all know what happens to cowboys, in trading. They get bucked.
If that is you, then go back to step 1 and play the game again (and again), until you pass all 10 levels. It is critical that you understand how much risk is optimal for any type of trading method.
Your risk management will keep you in the game longer than almost anything else.
After you figure out your risk tolerance, you can use a position sizing calculator to calculate your lot size on every trade. You can also use this technique to calculate your lot size. But that depends on your broker.
The bottom line is that the amount that you are comfortable risking per trade will probably be less than the optimal amount.
That's OK.
There are ways to make up for trading with less risk.
3. Test Different Forex Position Sizing Options
Now that you understand how much to risk on a trade, you can review and test your trade entry options. Most traders start off with trading one position and one profit target.
But there are many other variations that you can experiment with.
Be sure to test things like:
- 2R profit target: Instead of targeting just 1R, see if it makes sense to go for a little more.
- 50/50 Version 1: Maybe you can target 1R with half of your trade and 2R with the other half.
- 50/50 Version 2: You could also target 2R for the first profit target, then trail the second position in 1R increments.
- 80/20: Take 80% of your position on your first profit target, then put the other 20% on another profit target or a trailing stop loss.
There are obviously many other variations of trade entries, but these position entry ideas will get you started. Remember to download the Trading Strategy Development Worksheet and follow these instructions to keep track of the different variations.
Conclusion
So that is the best process that I have seen to figure out your ideal position sizing. Many beginners think that it should be the same for all traders and that simply isn't true.
You have to match it to your personality if you want to succeed. When you know your risk numbers, it makes entering trades much easier and allows you to trade any strategy from within your trading comfort zone.
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