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Those new to investing sometimes fail to realize how important money and risk management are. So I want to show you how learning to trade smaller can make you better returns.
If winning and losing trades were evenly distributed, trade size would not be a big issue. The problem is that winning and losing trades will often run in streaks. No trader knows how bad their worst streak will be until it happens and large position sizes can hurt your account balance during these streaks.
For example, imagine that you start with an account of $10,000 and lose 20% on a very big trade. You now have $8,000 in your account. In your next trade you win 20%, but that does not get you back to breakeven. Your account balance is now only $9,600. You will have to make 25% in your next trade just to get back to breakeven.
The problem illustrated here compounds very quickly when you have a string of losers. The larger your trade size, the bigger the hole becomes when you experience this run of losing trades. In the video below, I compared the returns of a profitable system with different positions sizes. You can see the results below.
-1% position size > Total return 10.5%
– 2% position size > Total return 8.26%
– 3% position size > Total return 6%
Recent market statistics about retail traders shows that the average forex account size in the United States is $7,000, and the average account holder trades an average of one lot 20 times per month. That is a pretty big trade size. If this “average trader” was using a 100 pip stop-loss, then they are risking 14% of their portfolio per trade.
If the average trader looks like this, it is little wonder that the burn-out rate in the forex is so high. Learning to reduce your trade size to be the “right size” is not easy. The correct trade size is a little variable and depends on your trading style, tolerance and expected returns.
However, one of the best things you can do now is to test whether you are currently using the “wrong” trade size. Take your trading history from your actual account and begin reducing the trade size in a spreadsheet. Assuming you have been consistent in your sizing, you should be able to easily tell whether you could have performed better with smaller trades.
Although it is attractive to take big risks for theoretically bigger returns, trading too big over a series of many trades will reduce your returns both in percentage terms and absolute dollars. Take the time to rethink how large your trades are and whether you are just sacrificing performance. [If you cannot see the video below, please try refreshing the page.]
For more on forex trading, see:
- Risk and Return in the Forex
- How to Avoid Getting Screwed Trading Currencies
- A Low-Risk Way to Trade Currencies
- Forex Trading: Long-term vs. Short-term Trading
- Learning the Ropes of Forex Markets
The Secret to Money-Doubling Trades: Learn a proven, time-tested strategy to finding money-doubling trades in a new report. It’s the trading “secret” so effective we were banned from sharing it with you — download your FREE copy here.
