Position size calculation

Trading Discussion
#1

I wonder if anyone could clear something up for me. I have been looking at calculating position size where the account denomination is different to the base and currency pair
So Lets start simple. Lets say I trade in US Dollars ($) and I have $10,000 and am willing to risk 2% per trade
That’s $200 dollars per trade - so far so good
But I’m trading GBP/EUR. So I need to convert my $200 dollar risk into the counter currency (Euros)
Using a USD/EUR of 0.9022 that’s 180.44 Euros
I then set a stop loss of 300 pips. That works out therefore at value per pip of 0.60 (rounded)
I will times 0.60 by 10,000 as the GBP/EUR is quoted to 4 decimal places which gives me 6,000 lots.

Being the bad trader I am my 300 pip stop loss hits and I have lost my calculated 180.44 euros
I don’t feel too bad as its only 2% of my account but wait - here comes my question.

I have lost 180 Euros but when that gets converted back to USD the exchange rate for USD/EUR has changed to 0.8000
180.44/0.8000 equals $225.55 which is more than 2% of my account.

So the only true way to keep a strict 2% of your account at risk in these circumstances is to change your position size every time your denominated currency and the counter currency you are trading change.
Effectively if you are trading in a currency pair where neither the base nor counter currency is your denominated currency then you are effectively taking on 2 trades and therefore doubling your risk.
Am I right in saying this?

#2

Your post has multiple issues.

First, you are using [I][B]inverted currency pairs,[/B][/I] and you are getting yourself tangled up.

There is no GBP/EUR pair — [I]it’s the EUR/GBP.[/I] Therefore, the counter currency in the pair you are trading is not the EUR — [I]it’s the GBP.[/I]

Also, there is no USD/EUR pair — [I]it’s the EUR/USD.[/I] (However, EUR/USD does not figure into pip-value calculations in this trade, so it’s irrelevant.)

Finally, I can’t follow how you calculated a position size of [I]6,000 lots.[/I]

Let’s start over. And let’s use a Position Size Calculator, and a Pip-Value Calculator.

You have an account denominated in USD, with a balance of $10,000. You want to trade EUR/GBP. You want to limit your risk to 2% of your account balance. And you want to set a 300-pip stop-loss. Let’s assume that the current price of GBP/USD is 1.4300 (a little later, we’ll use this price again, and having a fairly round number will be an advantage).

The Position Size Calculator tells you that you can trade 4,662 units [I](not lots)[/I] of EUR/GBP. If your account trades in micro-lots (increments of 1,000 units), then you can trade only 4 micro-lots (equal to 4,000 units). Let’s say you have a unit-account (such as Oanda), and you can trade in unit-amounts. Therefore, your position size will be 4,662 units.

The Position Size Calculator asks you for the current GBP/USD price, because it needs to calculate a pip-value as part of the position-size calculation. It does this internally, and doesn’t tell you the pip-value (although it could be configured to do so). Instead, you will have to use the separate Pip-Value Calculator to get that information.

Now we can start to deal with your question about the [I][B]currency risk[/B][/I] implicit in a long-term trade in which (1) the counter currency and the account currency don’t match, and (2) over the course of the trade, the pip-value changes significantly.

Let’s start by determining the pip-value at our assumed GBP/USD price of 1.4300. The Calculator tells us that, for this trade, the pip-value is 0.6667 USD per pip.

In your example (trading EUR/GBP in a USD account), the pip-value is determined by the price of GBP/USD. The price of EUR/GBP and EUR/USD have no bearing on this pip-value.

So, the question becomes: if the price of GBP/USD changes significantly over the course of your trade (changing the pip-value significantly), and your trade is ultimately stopped out, then how much additional loss would you suffer (over and above your $200 intended risk limit) due to the change in pip-value?

If you plug various assumed changes in the GBP/USD price into the Pip-Value Calculator, you will soon see that the calculated pip-value changes proportionally to the change in the GBP/USD price. In other words, if the GBP/USD price increases by 1%, then the pip-value in this trade will increase by 1%. If the GBP/USD price increases by 10%, then the pip-value will increase by 10%. And so forth.

So, while your EUR/GBP trade is losing 300 pips, how large a pip gain in GBP/USD do you want to assume?

If you assume a 300-pip gain in GBP/USD (from 1.4300 to 1.4600), then the Pip-Value Calculator tells you that the pip-value will change from 0.6667 USD to 0.6807 USD. You can multiply this new pip-value by your 300-pip loss and determine that your dollar-loss will be $204.21 (instead of the $200 risk you had intended to take).

If you assume a 600-pip gain in GBP/USD, then the pip-value will increase to 0.6946, and your loss will increase to $208.38.

If you assume a 900-pip gain in GBP/USD, then the pip-value will increase to 0.7086, and your loss will increase to $212.58.

You can see the pattern here — every additional 300-pip increase in the GBP/USD price, increases your loss by a little over $4.

If you were LONG the EUR/GBP, and if the GBP was gaining in value against both the EUR and the USD, you would be losing the money you intended to risk, [I]plus a small additional percentage of that risk-amount.[/I]

[I]In order to incur a massive additional loss[/I] (over and above your intended risk-amount), you have to assume the worst of all possible scenarios: namely, that the USD is declining significantly, the EUR is increasing (possibly significantly), and the GBP is increasing even faster than the EUR. And while all this is going on, you are LONG the EUR/GBP.

All that could happen. But, is it likely?

.

#3

Thanks for the detailed response. I think I understand and forgive me for using inverted pairs.

I think the simple answer to the question of “What is my additional risk when trading in a currency pair which is not my denominated currency?” is:

The percentage difference in the counter currency and denominated currency from the open to the close of the trade times the pip gain/loss.

If I only risk 2% and I lose that 2% (say $200) then a 10% movement in the counter currency and denominated currency would lose me only 10% of that $200 - so $20. Or in your example above the move was 2% and so would incur a $4 loss.

Seems small in the long run considering a 300 pip movement in my actual trade cost me $200.