Beginner's guide to position sizing in trading
Reading time: 10 minutes
Whether you trade currencies (Forex), stocks, commodities, or bonds, knowledge of position sizing is paramount and forms a key part of a trader’s risk management.
Whether they admit it or not, many successful traders have committed classic mistakes, with some even blowing up their entire accounts. This is just the reality of trading and often serves as a great learning tool. Interestingly, it is generally not the analysis that causes this failure; it is usually a combination of poor risk management and a lack of emotional understanding.
Spending time learning to define your risk allocation and accurately size your positions is a critical skill for a well-rounded trader. I understand that it is not as exciting as picking stocks and analysing charts – and this is probably one of the main reasons new traders tend to overlook it – but it is the difference between staying in business and getting wiped out.
Position sizing defined
As its name suggests, position sizing is the process of deciding how many units to buy or sell.
However, before you can determine the size of your position, you will need a couple of inputs, first being your risk per trade, commonly 1 or 2% of your entire account equity. To be clear, experienced traders often vary their risk allocation depending on the setup.
A high-probability trade – one that usually offers at least the opportunity to reduce risk to breakeven – is often entered with higher risk, say 3 or 4%; setups with a lower win ratio but form part of a trader’s overall strategy may only be traded with 1% risk, or less.
The next input needed will be the asset traded. Are you trading a currency pair, for example, or a stock, a commodity? Another important input required is the stop-loss distance, usually measured in pips or points; this is the distance between your entry and exit points.
To help solidify the definition, suppose you want to trade the EUR/USD currency pair, and you have a US$10,000 trading account. In this example, you have decided to risk 2.5% of your trading account on a trade: US$250.
Your analysis indicates strong support around US$1.0850, with the next layer of support around US$1.0825, meaning this trade has about a 25-pip stop-loss distance. Of note, your account is denominated in USD.
For those new to trading the Forex market, position sizing is done in ‘lots’. Commonly, you will find that brokers offer standard lots (100,000 units), or US$10/pip, mini lots (10,000 units), or US$1/pip, and micro lots (1,000 units), or US$0.10/pip.
So, with you risking US$250 on this trade, and knowing that with your account denominated in USD, the pip value is US$10 per pip for a standard lot. With this, you could open a position with 1 standard lot. If the trade fails to move in your favour and hits the stop-loss order, this would be a losing trade. However, if the EUR/USD rallied 50 pips, this would be a gain of US$500, double the initial risk.
Importantly, though, position sizing is not always as straightforward as this in the Forex market, and depends on your account currency’s denomination and the currency pair traded. For those who primarily trade Forex, the Team and I put together a three-part series here that goes into detail on the different scenarios you can face. For beginner traders, I would strongly recommend familiarising yourself with the FP Markets position sizing calculator.
Why does position sizing matter?
Many traders enter this business with the belief that all they need is a solid trading strategy that tells them where to buy and sell. If only it were that easy, trading would be far more straightforward.
Speak to any trader worth their salt, and I am sure they will tell you that they likely went down a similar route of hunting for the perfect strategy, the perfect indicator, or the perfect chart pattern, often overlooking risk management. What you will eventually learn is that even with a mediocre trading strategy, generating a return is possible over the long term if risk is managed. At the same time, an exceptional trading approach, one that boasts a high win ratio and risk-reward, can lose money over time if risk is not managed; it can come down to just one losing trade that wipes out an account.
This is why you will find that the majority of professional traders keep their risk-per-trade under 4%, varying their allocation depending on the setup’s probability. If your account is down 10%, with correct risk allocation and position sizing, that is recoverable. If you are risking 20% per trade, things can quickly become out of control. The maths of drawdowns is brutal and asymmetric – losing 50% of an account requires a 100% gain just to break even.
One refinement you will find some traders make is to adjust their stop-loss distance based on volatility, which then feeds into position size. A tool commonly used among retail traders is the Average True Range (ATR), which measures how much an instrument typically moves over a given period.
For example, if the ATR is higher, meaning this market has been more volatile in recent days, traders may increase their stop distance to factor this in. A wider stop, in turn, means a smaller position size for the same dollar risk. This keeps risk exposure consistent even as market conditions change, rather than accidentally risking more during volatile periods just because your stop distance stayed fixed out of habit.
Common position sizing mistakes
- Sizing your trades based on conviction rather than strategy. Feeling strongly that a setup will ‘work out’ is not good enough. A trade should be sized based on the setup’s performance.
- Risking a fixed dollar amount. By not adopting at least an account percentage risk strategy (meaning you risk between 1-4% of your account equity per trade), you run the risk of not scaling your account properly.
- Moving a stop mid-trade. This should be self-explanatory. You set your entry and stop levels before you submit your trade on the platform when you are objective and not emotionally charged. Moving your stop beyond the original point mid-trade is emotional, which naturally increases your position size.
Final words: Bringing it all together
Position sizing and overall risk management are, by far, one of the most important aspects of trading. It is vital to remember that as traders, we are risk managers first and foremost. I understand that risk management is not an exciting subject. It will not show you where to enter and exit. Still, you must recognise that without an understanding of position sizing, trading will be a very difficult endeavour.
If you are beginning in trading, I would strongly recommend shelving the chart analysis and focussing solely on understanding risk management. Think about your risk per trade, learn how to use the FP Markets position sizing calculator, and begin learning how to calculate this manually. Do the maths every single time, even when it feels tedious. Over hundreds of trades, that discipline compounds into something far more valuable than any single winning trade ever could.
Written by FP Markets Chief Market Analyst, Aaron Hill
Frequently asked questions (FAQs)
Position sizing is the practice of deciding the number of units to buy or sell. It is determined by your allocated risk per trade, your account equity, and the distance between your entry and exit points.
Yes, you can use a calculator to size your positions. In fact, for beginner traders, it is strongly recommended to use the calculator while familiarising yourself with manual formulas.
How much you should risk per trade depends on several factors and is always trader-dependent. Some traders stick to 2%; others vary their risk depending on the setup presented.
Some of the common pitfalls traders make, particularly those new to the business, include basing their risk allocation on conviction, rather than analysis and historical statistics. Another common mistake is risking a fixed dollar amount, which can cause you to fail to scale your account properly.
