Risk Management for Traders – Part One
Effective risk management is a must for anybody trying to choose trading seriously. Without funding, a trader can’t trade, consequently capital preservation ought to be the number 1 goal for each and every trader. Within this collection of tutorials, we’ll present a couple of the very crucial theories associated with hazard management.
Capital might also be emptied slowly with the years or within a brief time onto several trades, and sometimes maybe only 1 trade. Slimming capital gradually during a lengthy time period is ordinarily the effect of a bad trading platform or excess trading expenses. Losing capital fast results in risking too a lot of capital on private trades or bad area.
Risk management should, hence, become part of every phase of the trading platform, including strategy or method design and style, standing sizing and implementation.
Calculating Position Size and Exposure
It’s hopeless to handle risk should you not know what size your posture is how a lot of you’re risking. Having the capability to compute the vulnerability and risk for each trade is, hence, first matter to obtain overly familiar with. Even though this might appear obvious, a lot of men and women who’re not used to trading don’t know how big their trades actually are.
If you are trading stocks, calculating the size of a position is very straight forward:
Position size in USD = Share Price in USD x Number of stocks
For Forex and margined products like CFDs and futures, calculating the size of a position is slightly different. Remember, your store exposure is equal to the position size, not the margin required for a trade.
For both Forex and CFDs, if you know the tick value, you can calculate the position size from that. We will look at CFDs before all else.
Position Size for CFD Trading
Let’s say you purchase 1 CFD on the ASX 200 at an index level of 5,750 and one point is equal to 1 AUD. That means you will make 1 AUD for every point the index rises and lose 1 AUD for every point the index falls.
In this case, if the index rose 100%, the benefit would be AUD 5,750, so 100% of the position is AUD 5,750 which is the total position size.
If the one point was worth AUD 10, then the position size for one CFD would be AUD 57,500. If one point was worth AUD 25, then the exposure for one CFD would be 5,750 x 25, or AUD 143,750.
In some cases, the minimum tick size is measured in movements that occur to the right of the decimal place. For example, the minimum tick value for CFDs on the S&P500 is often 0.1 points or 0.01 points.
If the S&P500 is trading at 2,660 and the tick size is 0.1, with a tick value of $1, then one CFD is worth 2,660 x10 x $1, or $26,660.
If the tick size was 0.01 and a tick was worth $1, then one CFD would be worth 2,660 x 100 x $1, or $266,600. That may seem very high, but in reality, one tick is often worth only $0.1 or $0.01.
Position Size for Forex Trading
Calculating your exposure for a Forex trade is similar. The tick size is known as a pip, and for most currency pairs it is the fourth number after the decimal point. The exception is the Japanese Yen (JPY) for which the pip value is the second number after the decimal point.
If the GBPUSD pair is trading at 1.2821 and the amount rises to 1.2822, it has risen by one pip. But how a lot of is a pip worth, and what is the total value of a position?
For Forex, this depends on the contract size you are trading. Currencies are usually traded in lots. A standard lot is 100,000 units of the base currency, which is the before all else currency in the quote – i.e. GBP in the case of the GBPUSD pair. So, a standard lot for this pair would be GBP 100,000 which would be worth USD 128,210.
Fortunately, you can also trade mini lots which are 10,000 units and even micro lots which are 1,000 units. In the above example, a mini lot would be worth USD 12,821 and a micro lot would be worth USD 1,282.10.
For a standard lot, the pip value is $10, for a mini lot it is $1 and for a micro lot, it’s $0.1.