Pressing the buy or sell button is easy, but do traders actually know what they are doing with respect to trade size, margin, and equity management? Watch our short video to see how a pro analyst navigates a broker trading platform to quickly identify per pip value, margin requirement, and risk/reward setups.
When you’re trading the Forex markets, your position size (trade size in units) and margins are more important than your entry and exit levels. You may have the best strategy in the world, but if your trade size is too small or too big, you will end up taking on too little or too much risk.
So, how do we determine margin and trade size? How can these factors affect one’s equity management strategy? And how can one use them on a broker platform?
Let’s answer these questions one at a time.
Margin and Position Sizing
Margin is nothing but borrowing capital to increase the size of a trading position.
When you buy securities on margin, you borrow money from your brokerage firm to pay for all or part of the purchase price of securities you’re buying and agree to repay the same over time.
The amount you can borrow depends on how much margin is available in your account, which varies depending on your brokerage firm or the type of asset you’re buying using borrowed funds. By using margin, traders can magnify their returns if they’re right and lose more if they’re wrong.
Position sizing simply refers to the number of units the trader or investor has invested in a particular security. Traders use position sizing to know how many units of security they can purchase as per their risk-return expectations.
With position sizing, traders can know the size of a position in their overall portfolio and adjust the same to control risks and maximize their potential returns.
How Position Sizing and Margin Trading Works – An Example
For someone who is looking to start with the minimum investment amount in the markets, the rule of thumb is to start trading with micro lots rather than mini or standard lots. But when you’re willing to bet a decent amount of money in the market, determining the position size can help in enhancing your returns.
Let’s understand this concept with an example where we buy the EURUSD currency pair at 1.2031 levels with a profit target of 1.2226 and a stop set at 1.1940 level.
So, our risk on the trade is 91 pips (buy price of 1.2031 minus the stop loss of 1.1940) and the reward is at 195 pips (target price of 1.2226 minus the buy price of 1.2031).*
The next question is – How do you determine the amount you want to trade and risk on this currency pair?
Well, every currency pair has lots which you can buy and sell and the value for each lot differs for different currency pairs.
Here are the three lots for trading EURUSD:
- Micro lot: 0.01 lots (or 1,000 units)
- Mini lot: 0.10 lots (or 10,000 units)
- Standard lot: 1.00 lot (or 100,000 units)
With the above info, you can quickly find the amount of risk and margin for your trade on your trading platform. Here’s how…
Click on the EURUSD chart on your SmartTrader platform, click on ‘Trading’, and then on ‘Create New Order.’
You will now see an order page where you can place an order for the amount you wish.
We know the minimum lot i.e. the micro lot is for 1,000 units. When you enter this in the ‘Units’ box on the order page, it will show you the value per pip as 1 PIP = $0.10 and also give you the margin used for this micro lot trade, which comes to around $24.06
So, here’s what goes on when you decide to place an order on the EURUSD with a micro lot…
Your trade value is 1,000 units x the current price of $1.2031 = $1,203. And to trade this lot, you have to keep at least $24.06 as leverage in your broker’s account.
The risk with this trade is 91 pips of risk x $0.10 per pip value = $9.10.
And the reward here comes to 195 pips x $0.10 per pip value = $19.5.
Similarly, the value of risk on a mini lot and standard lot comes to $91.00 and $910, respectively, while the reward on these comes to $195.00 and $1,950.00.
Say, if we go ahead and trade with the mini lot, where the reward is $195 and the risk is $91.10, our reward to risk ratio comes to 2.14 (195 divided by 91.10), which is impressive.
So, that’s how you can know your risk and reward ratio before placing any trade, and also the position size and the margin that you will be using with it.
Let’s say you want to risk just $100 per trade, you can trade the EURUSD with a micro lot. On the other hand, if you’re someone who wants to bet big to capture greater potential returns, you can risk around $910 on this trade by buying a standard lot.
In conclusion, knowing your position size, risk and reward, and the margin for your trade goes a long way in having a sound and potentially rewarding equity management strategy.
In fact, we’ll go on to say that trade size and risk management are the most important aspects in any trading or investment strategy. And we believe they are the biggest edge differentiators that can separate successful traders from average or losing traders.
Chris Pulver, Senior Currency Strategist at Market Traders Institute, has recorded a short video on how one can navigate a broker platform to quickly identify per pip value, margin requirement, and risk to reward setups, which you can Watch Here. To know more about the systems, tricks, and strategies that Chris uses to target profitable trades, you can sign up for his free weekly newsletter here.
If you are looking to take your trading game to the next level with easy-to-use tools and potentially rewarding trades, register for one of Market Traders Institute’s free weekly webinars, where our experts will teach you live-market forex strategies that have stood the test of time.
Trading foreign exchange on margin carries a high level of risk, and may not be suitable for everyone. Past performance is not indicative of future results. The high degree of leverage can work against you as well as for you. Before getting involved in foreign exchange you should carefully consider your personal venture objectives, level of experience, and risk appetite. The possibility exists that you could sustain a loss of some or all of your initial deposit and therefore you should not place funds that you cannot afford to lose. You should be aware of all the risks associated with foreign exchange trading, and seek advice from an independent financial advisor if you have any doubts. The information contained in this web page does not constitute financial advice or a solicitation to buy or sell any Forex contract or securities of any type. MTI will not accept liability for any loss or damage, including without limitation any loss of profit, which may arise directly or indirectly from use of or reliance on such information.
*THESE RESULTS ARE BASED ON SIMULATED OR HYPOTHETICAL PERFORMANCE RESULTS THAT HAVE CERTAIN INHERENT LIMITATIONS. UNLIKE THE RESULTS SHOWN IN AN ACTUAL PERFORMANCE RECORD, THESE RESULTS DO NOT REPRESENT ACTUAL TRADING. ALSO, BECAUSE THESE TRADES HAVE NOT ACTUALLY BEEN EXECUTED, THESE RESULTS MAY HAVE UNDER-OR OVER-COMPENSATED FOR THE IMPACT, IF ANY, OF CERTAIN MARKET FACTORS, SUCH AS LACK OF LIQUIDITY. SIMULATED OR HYPOTHETICAL TRADING PROGRAMS IN GENERAL ARE ALSO SUBJECT TO THE FACT THAT THEY ARE DESIGNED WITH THE BENEFIT OF HINDSIGHT. NO REPRESENTATION OR WARRANTY IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THESE BEING SHOWN.