It has been said that the most important factor in creating capital in your trading account is the size of the position you take in your trading. In fact, position size will represent the fastest and most magnified returns a trade can generate. Here we take a controversial look at risk and position size in the forex market and give you some tips on how to use it to your advantage.
The undiversified portfolio
In the book The Zurich axiomsAuthor Max Gunther states that to break away from the “big non-rich,” an investor must avoid the temptation to diversify. This is controversial advice, as most financial advice encourages investors to diversify their portfolios to ensure protection against calamities. Unfortunately, no one gets rich from diversification. At best, diversification tends to balance the winners with the losers, thus providing a mediocre profit.
The author goes on to say that investors should “keep all [their] eggs in just one or two baskets “and then” take good care of those baskets. “In other words, if you want to really move forward with your operations, you will need to” play for significant stakes “in the areas where you have enough information to make a decision. investment.
To gauge the relevance of this concept, just look at two of the world’s most successful investors, Warren Buffett and George Soros. Both investors play for significant bets. In 1992, George Soros bet billions of dollars that the British pound would devalue and therefore sold pounds in significant quantities. This bet was worth more than a billion dollars practically overnight. Another example is Warren Buffett’s purchase of Burlington Railroad in a $ 44 billion deal, a significant stake to say the least. In fact, Warren Buffett has been known to scoff at the notion of diversification, saying it “makes very little sense to anyone who knows what they are doing.”
Big bets on Forex
The forex market, in particular, is a place where big bets can be placed thanks to the ability to leverage positions and a 24-hour trading system that provides constant liquidity. In fact, leverage is one of the ways to “play for significant stakes.” With only a relatively small initial investment, you can control a fairly large position in the currency markets; 100: 1 leverage is quite common. Additionally, market liquidity in major currencies ensures that a position can be entered or liquidated at cyber speed. This speed of execution makes it essential that investors also know when to exit a trade. In other words, be sure to measure the potential risk of any trade and set stops that will get you out of the trade quickly and still put you in a comfortable position to take the next trade. While entering large leveraged positions provides the ability to generate large profits in a short time, it also means exposure to increased risk.
How much risk is enough?
So how should a trader play for meaningful bets? First, all traders must assess their own risk appetite. Traders should only play the markets with “risk money”, which means that if they lost everything, they would not be destitute. Second, each operator must define, in monetary terms, how much they are willing to lose in a single operation. So, for example, if a trader has $ 10,000 available to trade, he must decide what percentage of that $ 10,000 he is willing to risk on any trade. Generally, this percentage is approximately 2% to 3%. Depending on your resources and your appetite for risk, you could increase that percentage to 5% or even 10%, but I wouldn’t recommend more than that.
So playing for significant stakes takes on the meaning of managed speculation rather than wild gambling. If the risk / reward ratio of your potential trade is low enough, you can increase your bet. This, of course, begs the question: “How much risk will I reward on a particular trade?” Answering this question correctly requires an understanding of your methodology or the “expectation” of your system. Basically, the expectation is the measure of the reliability of your system and therefore the level of confidence that you will have when performing your operations.
To paraphrase George Soros, “it is not whether or not you are right that matters, but how much you earn when you are right and how much you lose when you are wrong.”
To determine how much to stake on your trade and get the most return on your investment, you should always calculate the number of pips that you will lose if the market goes against you if your stop is hit. The use of stops in currency markets is often more critical than for investing in stocks because small changes in exchange rates can quickly result in massive losses.
Let’s say you have determined your entry point for a trade and have also calculated where you will place your stop. Assume this stop is 20 pips from your entry point. Let’s also assume that you have $ 10,000 available in your trading account. If the value of a pip is $ 10, assuming you are trading a standard lot, then 20 pips equals $ 200. This equates to a risk of 2% of your funds. If you are willing to lose up to 4% on any trade, you can double your position and trade two standard lots. A loss on this trade would of course be $ 400, which is 4% of your available funds.
The bottom line
You should always bet enough on any trade to take advantage of the largest position size that your own personal risk profile allows, while ensuring that you can still capitalize and profit on favorable events. It means taking a risk that you can bear, but doing your best whenever your business philosophy, risk profile, and particular resources adapt to such a move.
An experienced trader must stalk high probability trades, be patient and disciplined while waiting for them to settle, and then bet the maximum amount available within the limitations of his own personal risk profile.