Risk is generally defined as [B]how much you will lose if your trade goes bad.[/B] And “going bad” generally means that you get stopped out. [B]So, your stop-loss (in pips) must figure into your position-size calculation.[/B] (Your R/R ratio, by the way, has no bearing on this calculation.)
Let’s say that the trade you are considering requires a [B]30-pip stop-loss.[/B] If your trade is stopped out, you want your loss to be equal to (or less than) 2% of your capital. That is, a 30-pip loss must not exceed £80.
[B]Therefore, 1 pip of profit or loss on this trade must not exceed £2.66[/B]
Now, let’s say that you are going to trade the [B]GBP/USD.[/B] Using a pip-value calculator (I used the Babypips calculator), we know that 1 pip is worth £0.062 per 1,000 units of base currency (at the current GBP/USD price of 1.6130).
[B]From this, we calculate that your position size can be up to 42,903 units of base currency (1,000 x £2.66 / £0.062).[/B]
If your trading account lets you set your position-size by units, then you can trade [B]42,903 units of GBP/USD.[/B] Oanda offers this type of account, and there may be other brokers who do, as well.
If your account lets you trade in nano-lots (100 units), then you can trade [B]429 nano-lots.[/B]
If your account lets you trade in micro-lots (1,000 units), then you can trade [B]42 micro-lots.[/B]
If your account lets you trade in mini-lots (10,000 units), then you can trade [B]4 mini-lots.[/B]
(You can’t place this trade in a standard account, because 1 standard lot, together with your 30-pip stop-loss, would exceed your 2% risk limitation.)
You’re welcome. That lengthy explanation was intended to show you the relationship among these metrics: account balance (capital), your selected risk limit (2%), your trade risk in pips (that is, your stop-loss), your account currency (£), and the currency pair you intend to trade.
Usually we don’t spend a lot of time calculating things like this by hand, if there’s an easier way to get the answer.
If we can’t figure something in our heads, we look for a tool to do the work for us.
If you had asked, “What’s the quickest way to find the correct position size?”, the answer would have been to use the Babypips Position Size Calculator. But, that would not have shown you how the answer was derived.
Here is your example, entered into the Position Size Calculator.
It took less than a minute to open the Calculator, enter the specific numbers required, and get the answer:
If you’re paying very close attention, you noticed that the Position Size Calculator shows a slightly different number of units (43,013) from the number that I calculated (42,903). This difference is due to a change in the price of the GBP/USD over the past 20 hours, slightly affecting the pip-value — and, therefore, slightly affecting the position size calculated.
This might be an old thread, but I would like to thank Clint for explaining it so well!
I’m done reading that section in the School, but did not understand it there because I had a different concept of it.
