Why Is Proper Position Sizing Important?

Updated from its original posting on 2012-11-02

We here at BabyPips.com believe that proper position sizing is THE single most important skill a trader should have. Yup, that’s right – it’s THAT critical!

Simply put, position sizing is all about setting the correct amount of units to buy or sell a currency pair. It is a key element in risk management, which can determine whether you live to trade another day or not. It can keep you from risking too much on a trade and blowing up your account.

Sure, when you bet big, you can win big. But what happens when you lose? Well, you don’t need to be a brain surgeon to figure that one out – you lose big, too.

Without knowing how to size your positions properly, you may end up taking trades that are far too large for you. In such cases, you become highly vulnerable when the market moves even just a few pips against you.

When calculating your position size, you should determine and acknowledge your risk profile. If you catch yourself about to bet big on a certain trade, ask yourself why you are about to do so. Nobody does something just for the heck of it. Binge eaters don’t just overeat just so they could eat a lot. In one way or another, they get something out of it. Some sort of self-fulfillment perhaps.

The same is true for a trader who always finds himself betting too much on his trades even when past experience tells him it’s not a good idea. Why does he keep on doing it?

A little introspection can make one realize that it’s more than just about being greedy. For most traders, they realize that their aggressive behavior is tied to their self-worth. They bet big in hopes that they win big. The prospect of massive gains consequently makes them feel good about themselves.

The problem though is that they don’t fully understand how much they could lose and they find themselves being unable to control their emotions when price goes against their way, even by just a few pips.

In order to address it, one has to acknowledge that there is indeed a problem and that will make a trader realize that this mindset is flawed. With time and conscious effort, he will eventually realize that his trading positions don’t measure his worth as a trader.

Another thing to keep in mind is your tolerance for risk. There are two opposite sides in the trading spectrum, with one extreme being risk-seeking and the other being risk averse. Do you know where you stand?

Although most traders risk a fixed percentage of their account on a trade, there’s no one-size-fits-all method to go about it.

Before you even get to the mathematical aspect of it, you first need to determine your psychological limits for risk. If you’re unsure how to go about it, take it slow. Adjust your position sizes according to the potential losses that you know you can sustain. The basic rule is to keep them small enough so that even when you lose, they don’t evoke any strong emotional response that could derail your trading.

Often times, traders make the mistake of focusing solely on finding the perfect entries and exits. But what really spells the difference between successful and unsuccessful traders is risk management. It’s something that should never be taken it for granted. And the first step towards smart risk management is proper position sizing.

  • jabby

    Your my best teacher ever. The major part of being successful is being wise in acting in any market and you’re the wisdom

    • Dr. Pipslow

      Thanks so much for checking out my blog and for the very kind feedback. See you around!

  • I’m new to Forex, but I have some experience with stocks and I don’t trade with size that I’m not comfortable with (depending a stock’s nature , chart and price action and pending news…etc)

    thought provoking post

    Akos

    • Dr. Pipslow

      That’s a good rule of thumb – just trade with a size that you’re comfortable with. Thanks for reading my post!

  • Fawkes

    Babypips is the best. Full of gems like this.

    • Dr. Pipslow

      Thanks for the positive feedback. Glad to have you as part of our BabyPips.com community so I hope you stick around!

  • Rod

    Aaah just what the Doctor ordered, I wait for your posts they the most valuable to me. Self awareness within the trading realm is most important to me, thank you

    • Dr. Pipslow

      Thanks for checking out my blog and for the positive feedback! Just glad I could help out 🙂

  • william

    I am new to all this but your post is very wise word everyone should listing to them

    • Dr. Pipslow

      Thanks for reading my blog! See you around!

  • Peter

    Thank you for educating me a bit on trading. In fact I lost a lot of money in trading. Whenever I place my order, it turns against me. Keep on helping us that are new to trading. Bless you.

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