Adding to a winning trade: forex position sizing and risk profile
Adding to a winning trade: 3 forex position sizing models
A succcessful trend forex trading strategy should not only seek to maximise trading profit by staying with a winning trade as long as possible but also to attempt to add to the position. Adding to a winning trade should be part of a personalised trading plan but its success depends on the re-entry level, maintaining moving stop loss, position sizing and taking care of overall risk profile.
I present below 3 models for forex traders to consider when adding to a winning forex trade. The emphasis of the models lie on positioning sizing and their impact on overall risk as measured by average price of the entire position.
To prevent the models from becoming unwieldy, re-entry and stop loss is not included in this discussion.
3 forex position sizing 4-step models
In each model, a trade begins with an initial entry price of 1.30000 for EURUSD. We simulate a long position. Position size is increased each time there is a 1-percent rally in price. We use a factor of 2 when we determine the position sizing i.e. a 2x,1/2 factor.
Model A upsizes the position by entering an additional position that is double the previous entry. The position sizes are in this sequence: 100k (10 mini), 200k, 400k and then 800k.
Model B upsizes the position with fixed additions of 100k each after the initial position of the same amount.
Model C halves each subsequent additional position size so that the sequence looks like this: 100k, 50k, 25k, 12.5k.
Stop loss is not featured in all three models. However, calculations for each model look at the percentage of price correction to knock the entire position back into loss at the end of the 4th entry (Step 4). This percentage represents risk. The less the correction it takes to go back into red, the more dangerous the model.
Risk is also demonstrated in another way: How much loss will the trader encounter in the entire position if there was no stop and price retreated back to its level at the initial entry. Lastly we look at the value proposition offered by each model by assessing reward to risk ratio. This is calculated by dividing the profits at Step 4 by the loss if the position went back to the first entry price at Step 1 with no stop.
The larger the upsize, the riskier the position
Among the three models, Model A can withstand the smallest price correction before going into a loss. If we were to envision the position sizing for Model A, it would appear to be an inverted triangle trying to stand on a bottom apex. Average entry price can be fairly represented by centre of gravity (CG). In the inverted triangle, a high CG makes the position shaky and near to tipping.
Model C on the other hand has a wide base and narrow top. Its deep CG ensures that the position can stay positive in spite of deeper correction. It has a more attractive value proposition as well since reward to risk ratio is 3 times.
Without a trailing stop loss, Model C is definitely the recommended position sizing model.
Variations to this simulation
It would be interesting to see if the different outputs look similar if this was a short position. Other variables include:
- Changing price increments from 1%
- Changing position sizing factors such as 3 (3x, 1/3), 4 (4x, 1/4) or 5 (5x, 1/5)
- Incorporating some kind of step-based or moving average based trailing stop (which may change the value proposition)
- Also forex leverage and forex trading margin is not included here. If we look at this measure, we probably need to see its impact on return on trading capital.