Everybody who has taken more than few trades knows that some of them result in loss. Some people stay in loosing positions in hopes for markets to turn around and produce profits. While it might work on few occasions, it is only a matter of time before this kind of trading will end in a margin call, effectively ruining account. Or, the wait period is measured in months or years, before price turns in the direction desired and reaches profitability. To avoid this, most traders use stops to cut looses short and preserve trading capital.
Unfortunately, vast majority of people entering trading arena have only gains in mind, leaving them unprepared for losses which are inevitable. They do not know how to deal with this reality of trading and how to manage them properly. This creates huge psychological problems, mental blocks, fear and eventual departure from trading.
Losses should be viewed as a cost of doing business, not much different than paying phone bill, rent or any other customary expense. Another analogy could be made with retailers who stock up on merchandise that doesn’t sell. They discount it, sell it at as small loss as possible in order to recover capital. Then other items can be acquired, which, hopefully, will sell much better and recoup previous loss. Trading is exactly the same. If price moves against the trade, one has to get out, salvage as much funds as possible and wait for better opportunity.
Next, trader must find “comfort level” for loss. This is very personal and will depend on risk tolerance, account size and other similar variables. It can not be discovered from books and trading manuals but rather through personal trading experiences. One should experiment with position size in order to find out when losses don’t bother him/her too much. This is easy to do now, as most brokers offer not only standard size lots, but also minis. Some even allow trading in hybrid lot sizes, which is great, since it permits really precise tailoring of amounts traded.
For example somebody trading $10,000 account might find it hard to stomach an average loss of $1000, but $50 or $100 would likely be easy to take. This could be a starting point. Position size small enough that a loss is no larger than, say $100. Once a trader doesn’t have any problem with this level of an average loosing trade, position size can be increased and process repeated. One has to also remember that loosing trades often come in streaks. This process of starting small will help trader to deal with multiple failed trades in a row.
Profits also depend largely on the size of an average position, so a careful balance has to be established. One person might be willing to take greater risks in order to reach bigger gains, while other will concentrate on keeping account draw downs to minimum at the expense of gains. This is very personal, for which there is no universal, fit all mold. Everybody has to find his/her own comfort zone.
This process of starting very small and increasing trading levels might take some time before optimal position sizing for given trader is discovered. It could easily last several months, but is well worth it. Not only will it built loss tolerance, thicken the skin, but will greatly enhance trader’s chances for long time success. Becoming a trader is not an event but a process and requires time.
Mike K.
About 6 months ago I bought a trading system and opened an account with 15,000 dollars. By now I have about 7200 left. Losses vary from 200 to 450 dollars. What should be my proper position size and a stop loss? My broker is Oanda FX.
Since you lost half of your money, seems like the system you are using is a loosing one. While it could be a fluke, due to unusual market conditions over last few months, unless the system has a proven record of recovering from this kind of losses, you might have to get another system, or better yet, develop your own strategy. Contact system seller for historical results, the more the better.
“Proper” size depends on your own risk tolerance and that’s what this article is about. You can start trading with no margin, say $7000-7500 lots. 100 pips loss would be about $70-75 and very somewhat depending on the currency you trade. If you find that you can sleep easily after an average loss, bump the size up to about $10,000 and trade that for a while. Keep doing it untill you find comfortable trade off between gains and losses. But first of all, give this system a second look. Good news is, with Oanda you can trade any size you want, to a single dollar.
This makes perfect sense. I’ve been trading using a fixed ratio to determine my stop/loss, an advice from one the better Forex trading books on the market. But I must admit they are a little too big. I seem to dwell on them a lot. I think you are right, cutting position size should be easier psychologically.
Whichever book you are reffering to might very well be right, but you still must make some adjustments to fit your own comfort zone.
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