Forex

I took my first trade in months this past Thursday. I have been slowly trying to get back into the forex market by cautiously watching the GBP/USD. It's been a while since I followed any currency pair so I wanted to be sure that I watched the GBP/USD for a couple of days before taking any trade. I've decided to start referring to my profits/losses in terms of expectancy. Expectancy is "simply the mean or average R-multiple generated." (Source:http://www.iitm.com/sm-Expectancy.htm)

The "R" in R-multiple is short for risk. The best way to understand it is to either read the source above or continue reading. Let's take my first trade as an example. I knew my total dollar risk before entering the trade, that amount being $650.94. (yes, that exact) I exited half of my position when I had profited $329. I moved my stop to breakeven on the remaining position. Unfortunately I was stopped out on the rest giving me a total profit of $329. To figure out the R-multiple, you would take (profit / amount risked) which in this case was $329/$650.94 = .5R. Ideally, the higher the R in a profit situation, the better. For instance, a 2R multiple would be obtained in a 2:1 reward/risk trade and a 3R multiple in a 3:1 reward/risk trade. In a loss situation, a higher R is actually worse. Ideally, if you lose on a trade, the R-multiple should be 1R or less. If it's 1R, it simply means that you lost the amount you were expecting to risk. So in my above example, if I lost $650.94 on the entire trade, my R-multiple would have been 1R. Let's just say that I got stupid and decided to stay in the position and not honor my stop loss setting. Because of this stupidity, let's also say that I wound up losing $1301.88, twice as much as my initial risk. Calculating using (loss / amount risked) I would have an R-multiple of $1301.88/$650.94 = 2R.

So what does all of this mean? Well, I only have 1 trade to calculate my expectancy which would currently be .5R. I'll get more into calculating mean expectancy once I've compiled more trades. But having .5R isn't desirable because it basically means that I risked twice as much as the reward I obtained. This is exactly why I want to try to use R-multiple when I talk about my trades because even though I had a $329 profit on my first trade, it isn't as rosy as it may seem. The R-multiple was only a .5R and although it was profitable, if I trade this way in the long haul, I'll surely lose.

Another good source that also mentions the critics of R-multiple can be found at http://tradermike.net/2006/09/r_r-multiples_defined/

Popularity: 11%

UPDATE (January 2008) I’ve created an AJAX forex position size calculator that performs the calculations for you. You can find it at http://www.forexcalc.com

Here is a complete checklist to determine the most important aspect of money management, position sizing.

1. What is my account balance? $4234.58

2. What percentage of my account balance will I be risking? 1.0%

3. What is my stop loss on this particular trade? 50 pips

4. What currency pair am I trading? GBP/USD

5. How much is a pip worth on a 10K (mini) account? $1

6. CALCULATION What is my dollar risk amount? (Account Balance x Percentage Risk) $42.35

7. CALCULATION What is my position size (Dollar Risk Amount x 10000) ÷ (Stop Loss x Pip Worth)

NOTES

1. None.
2. It’s up to you to determine what percentage of your account balance that you want to risk. I’ve heard traders risking from 1.0%-5.0% per trade. I risk no more than 1.0%.
3. It’s important to determine what your stop loss will be before continuing with the checklist.
4. None.
5. This is the hardest to determine by hand with the exception of currency pairs with the USD in the quote currency such as the GBP/USD, EUR/USD, and AUD/USD. These currency pairs always have a pip worth of $1 on a 10K (mini) account. For other currencies, it’s easiest to use a pip value calculator. Make sure you use the pip value from the "Lot 10,000" column.
   
6. This is easy. Take the account balance and multiply it by .01 (1.0%), .02 (2.0%), etc. to obtain your dollar risk amount.
7. This is the most important calculation. Do it right.
   

EXAMPLE #1 (Answer questions 1 - 7)

1. $4234.58
2. 1.0%
3. 50 pips
4. EUR/USD
5. $1
6. USING A CALCULATOR-> ($4234 x .01) = $42.35
7. USING A CALCULATOR-> ($42.35 x 10000) ÷ (50 x $1) = (423500) ÷ (50) = 8470 units
   

What you might be thinking… I can only trade a mini-lot which is 10,000 units. This is more than my calculated position size. This means that you are under-capitalized. You need more capital to trade mini-lots. Another option is to use a variable-lot size broker like Oanda where you can specify 8470 units. Another option is to risk a smaller percentage per trade (use 0.5%.)

EXAMPLE #2 (Answer questions 1 - 7)

1. $10582.26
2. 2.0%
3. 75 pips
4. USD/JPY
5. $0.8829
6. USING A CALCULATOR-> ($10582.26 x .02) = $211.65
7. USING A CALCULATOR-> ($211.65 x 10000) ÷ (75 x $0.8829) = (2116500) ÷ (66.22) = 31962 units

In this example, you could enter a trade in the USD/JPY with 3 mini-lots or 30,000 units. If you have a variable-lot size broker like Oanda, you can enter a trade with 31,962 units.

There may be a better or quicker formula for calculating position size. This method works but if you know of a more efficient way, let me know.

Popularity: 10%

The blog’s been silent since Sunday which usually means I’m busy doing other things or concentrating on trading. That has definitely been the case this week. I’ve been participating in the forex trading contest, getting Metatrader primed and ready for backtesting expert advisors again, finishing the development of a new AJAX forex position size calculator, trading for real, and working my real job. Being busy is probably common for a lot of you out there too who are trading forex but have real jobs and responsibilities.

I’ve searched around for a forex position size calculator but what I mostly found were pip value calculators, excel calculators, or calculators that were part of some proprietary trading platform (like Oanda’s.) I didn’t find what I was really looking for which was a simple calculator that gave me a recommended position size in units and where I just had to enter my account balance, the percentage I want to risk on a trade and my stop loss. So this is exactly what I developed. It’s completed and in beta at http://www.forexcalc.com. It currently only works with accounts in USD but I’ll expand on that later. You have a choice of determining the position size for 110 currency pairs, way more than you’ll ever need. It also works no matter what your account size is. It can be $1 or $10,000,000 though I doubt anyone with an account this big would utilize it.

Popularity: 10%