Limiting risk is the number one goal of speculative traders, and position sizing is one of the preferred tools used to curb losses. We’ve composed a few tips to help you learn how to apply these strategies to Forex trading.
How to maximize profits while limiting losses
Limiting losses is the number one goal of speculative traders, after making profits of course. Position sizing is the number one tool they use to do this. Position sizing allows traders to mitigate their risk while maximizing potential profits; it is the key to protecting capital without putting undue limits on the potential for profits.
To start, you must use sound technical entry points for these techniques to work. The idea is to choose the best trades possible. Be on the lookout for trading opportunities with the highest probabilities of success, and then use position sizing to protect your funds in the event a trade goes bad.
The idea works on the principle of percentages combined with the golden Percent Rule. In short, the percent rule is that you only risk a certain percentage of your funds on each trade. A risky trader may rise 5% or 10% while a risk-averse trader may choose only to risk 1%. For example, in binary options, where each trade is a set all-or-nothing return with no chance to stop losses, this means making small trades. If your account was $9,000 as is the one in the example below it would mean trading only $90 with returns near $75 per trade.
If you are trading Forex or CFDs with IQ Option broker, you can use the take-profit/stop-loss Autoclose Tool if you prefer to make much bigger trades. Why? Because of position sizing. The stop-loss allows you to set a sell order to close the trade at a given amount. If your risk tolerance is $90, this means you can trade as much as you want, so long as you set the stop-loss to close at a loss of only $90. The question now is, how to set the stop-losses to maximize your profits and minimized the losses. That depends on you, but we’ll provide you with a step-by-step, detailed example in the next section.
Position sizing: how to set up stop-loss
Setting the stop-loss is easy and goes back to the percent rule. A good, safe rule of thumb is to use a 3% rule. A 3% risk is enough to make decent return without breaking the bank on a string of losses. This means a risk tolerance of $270 in my $9,000 account. The next step is to figure out how big a trade to make. You don’t want the $270 to be too large or too small a portion of the trade in order to allow some wiggle room, but not so large you lose more on a bad trade than you need.
I like to use 30%. This gives plenty of room for the assets price to fluctuate without exposing too much capital to losses. It also means that my trade size is right at 10% of my funds, which means a sizeable return on profitable trades. Now, let’s talk about putting the percentage to work. Look at the chart below. You can see that the available cash here is just over $9,000. A 3% risk means trade risk of $270 and a trade size of $900, $270/0.30=900.
When setting up the trade enter these amounts into the Trade Amount and Autoclose windows and you are all set. For your convenience, here are two formulas worth taking into consideration:
- Account Size x Percent Rule = Risk Amount
- Risk Amount/By stop-loss % = Trade Size
As a bonus, I tend to also set take profit. This way, you are able to walk away with your gains already secured. You know what they say: a profit isn’t a profit until you have closed the trade.
To start, 50% is a good setting, if the trade looks good you can always adjust the stop-losses and take-profit targets. With both settings in place a trader can walk away from the screen with no worries and let the trade play out as it will. A trader’s ability to trade depends on their funds, so taking the appropriate step to minimize losses is absolutely crucial. Remember: don’t risk more than you can afford to lose.
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