By Taylor Wilman

One of the things most retail foreign currency traders (old or new, experienced or inexperienced) often take for granted or simply disregard completely is position sizing. Having been lured into trading currencies by the high leverage it offers and the prospects of making windfall profits using very minimal capital, retail forex traders normally take the plunge immediately unmindful of the risk of over leveraging.

Of course they set up their trades carefully and studied existing fundamentals and current technical signals thoroughly having learned from the horrible experiences of other traders in the past. But that is where the problem crops up. The more thorough they studied the market, the more convinced they become of their trade set ups and proceed to trade – unknowing or simply unmindful of the risk of an account blowout which may result from over-leveraging their positions.

Quite often, they set up their trades and initiate large positions where they can maximize returns – having convinced themselves that there is no way the market is going to turn against them. The more careful among them will usually incorporate stop loss orders in their trades. However, their stop loss orders are based on their desired position sizes. Almost always, they have no choice but set the stop loss orders wide because of their large positions so they won’t be triggered out of the market prematurely. They fail to realize that their risk of ruin becomes bigger too.

Nothing can be a more perfect recipe for disaster than this. When the market turns against them quickly as it often does, they freeze in fear and run for cover albeit too late. They end up with a severely impaired capital that will severely handicap their future trades or worst prevent them from initiating new trades.

Position Sizing is your Key to Trading Success
The main flaw of the highly volatile foreign currency market is the persistent and seemingly permanent occurrence of excessively wild price swings. You never know when it will go against you. No matter how diligent you were with your analysis prior to setting up a trade you can still be whipsawed. And if you happen to have a large position in the market, a single loss may cripple you for good.

There is no system that can call the shots correctly 100% of the time. You are more likely to string a series of losses before you hit a big one. The logical approach therefore is to trade in a way that you can continue to set up future trades even after being hit by successive losses. This is what position sizing is all about.

Don’t forget that the reason why you are into retail forex is because you have very limited capital. It is perfectly alright to aim to double or even triple it but you must also have provisions in place to protect it from being wiped out in a single trade or a series of trading losses.

Position sizing is about deciding how much of your capital must be exposed on each trade. There are different ways of determining sizes and it varies from trader to trader according to their risk tolerance and available trading capital. The rule of the thumb here is not to risk more than 2.5% of your available trading capital on a single trade which means limiting the number of lots to no more than what the 2.5% can buy. This way it will take 40 successive losses to wipe you out completely which is a statistical improbability – unless you are a really dumb trader who is better off playing craps in a casino.

Article by Taylor Wilman