Tied to risk/reward, the size of your positions dictates how much you are willing to risk per trade versus how much you will gain. As a general rule of thumb, I risk no more than 1% or 2% of my portfolio on each trade. That allows me the potential to gain as much as 6% per trade if adhering to a 1:3 risk/reward ratio.
In terms of position sizing, money comes first, not pips. This is important.
Just as stop losses and take profits are dynamic and relative to the market you are trading, so should be your position size. For example, GBP/JPY is a very volatile pair to trade. I might consider expanding my stop loss to 50 pips on a GBP/JPY trade based on its history of oftentimes erratic and volatile nature.
And just as I expand my risk in pips, so I adjust my position size. Many traders make a common mistake of not adjusting their position sizes in accordance with more risk assumed in terms of pips, and the consequences of this are typically fast and painful if bad entry is taken. I’ve known several traders to wipe out accounts quickly (and I mean very, very quickly) trading GBP/JPY, assuming the same position size as they would with a less volatile pair. But fundamentally, they were wrong from the beginning.
The psychological consequences of seeing 50 pips tear against you at full position size in a matter of minutes is not something you want to deal with. By understanding the dynamics of the market you are trading, and adjusting your risk accordingly, you can withstand any ups and downs as with any ‘normal’ trade. Greed is typically the factor in trading full-size on a pair like this, not brains. But brains tend to prevail over time.
What is also important to note is that the $ amount per pip on certain pairs varies. For instance, I trade in a USD denominated account. For me, 1 EUR/USD contract is equal to $10/pip, whereas 1 USD/CAD contract is currently worth approximately $8.37/pip. I would adjust my position size according to maintain the same money management rules on the USD/CAD position as I would on the EUR/USD position.
