# Position Size Management Explained

Many, if not most, Fo cashbackforexreviewex traders trade a fixed number of contracts at a time How Forex Rebates Work the same number of contracts HowForexRebatesWork each cashback forex pair. It premiumrebateforex not the same as gradually modifying the number of contracts according to the direction of the trade in your favor (known as a "scaling" strategy). The first approach starts with a fixed position size, e.g. one or two contracts per trade, and then switches to a risk-based approach, also known as the fixed risk approach, meaning bestforexrebaterates the maximum risk per trade is a percentage of the full position (e.g. the classic 2%) and you determine the number of contracts based on the percentage of money you plan to lose (as a function of the stop-loss level) Variable risk/fixed risk Another important application of position size management is to modify the number of lots you trade between currency pairs, for example, instead of trading one lot of each currency pair in each set of trades, you trade two lots of one currency pair, and two lots of the other currency pair. For example, instead of trading two lots of each currency pair in each group, you trade two lots of one currency pair, three lots of another currency pair, and one lot of a third currency pair You allocate different lot sizes according to recent profitability, allocating more contracts to pairs that generate high profits and zero or low losses Whether the profits come from your excellent trading system, your personal wisdom and skill, or anything else, it doesnt matter if you make 18% per month on currency pair A and 6% per month on currency pair B. You should regularly (e.g. monthly) analyze the profit/loss ratio of each currency pair and allocate funds for subsequent trades based on recent performance. The benefits of managing position size in commodities trading were first mentioned in Ralph Vinces books, TheMathematicsofMoneyManagementand One of the problems with Vinces book, which is not for the faint of heart, is that Vince suggests allocating funds based on a starting point known as the optimal f-value (optimalf); where the value is calculated using the maximum loss ever experienced in the security. However, Vinces method has the advantage of allowing you to start thinking of successful trading as a statistical exercise. This doesnt mean you need to learn statistics before you can trade, but it does mean that trading and gambling have some hard and fast rules in common As you know, a lot of the initial statistical work started with the study of gambling Vinces optimal f-value is actually This formula was named after a mathematician (1956) and was eventually used for many other purposes, even in casinos and on Wall Street, where it was rumored that Warren Buffett also used it after the most reported use of the Kelly formula. The most famous book on the subject is BeattheDealer by Edward Thorpe (1956) In addition, the most comprehensive and readable review is FortunesFormula by William Poundstone (2005). sFormula) If you want to read about the mathematics of trading, Fortunes Formula is ideal for you. For most traders, the math behind Kellys Formula is complex, but there is one thing you must know: the percentage of money you put into a trade (betting percentage) is equal to "edge" divided by "Your "edge" is the percentage of profit you make on a trade that is a winner and that you know comes from your historical trading results. your profit/loss ratio where: Kelly ratio - the percentage of money invested for a single trade - the win rate of the trading system over time - the average profit/loss over time by Kelly ratio you will get the "best "The problem with it is that after each trade you have to recalculate its value. Another problem is that allocating money exactly according to the Kelly formula can lead to catastrophic losses, i.e. Vinces idea of replacing the average loss with the worst loss in the Kelly formula. -Some traders try to reduce the risk of the Kelly method by using half of the Kelly ratio - i.e. "half Kelly ratio" or 25% of the recommended amount - i.e. "1/4 Kelly ratio". VanTharp wrote a book called "TheDefinitiveGuidetoPositionSizing" and made some changes to the Kelly formula so that it is more accessible and easier to apply for readers who still dont intuitively understand it Tharp says that strict use of stop-loss levels and position management are more effective ways to keep accounts alive Some of Tharps advocates take his philosophy further: stop-loss setting is risk management and position management is money management, which is debated by many, but more importantly, you may have the best stops in place, but if you dont manage your positions well, you wont achieve optimal performance (even if your trades dont fail). For example, suppose you have $100,000 and are willing to risk 1% or $1,000 on your next trade with a currency price (AUD/USD) of .8950 and a stop loss of 20 pips or .8930, then your risk is 30 Divide the predetermined risk ($1,000) by $300 to get 3.3 contracts, i.e. you can buy roughly 3 contracts "Risk" always means the amount you are willing to lose in a single trade In this example, 1R is $1,000 Please note that risk is not intrinsically linked to the price movement of a security; you The R method does not provide any profit target or return expectation - it only controls the dollar amount and percentage of loss by trading the correct number of contracts You should choose your profit target based on your own exit rules, such as 2R or some other number If you successfully exit with a return of 2R, your return in this example would be Please note that Tharps books and seminars are expensive and you do not need to have statistical knowledge or complex calculations on a spreadsheet. This means that many traders enter more contracts (than the brokers leverage rules allow) and thus take on too much riskEarnForex offers two position size calculators for you to use when trading: a simple web form and a feature-rich downloadable version of the MetaTrader indicator. Both calculators are free to use and help you to create the most suitable trade size for your risk tolerance