Educational Information from AlgoTradingBots
What is position size and margin?
Position Size:
Position size refers to the number of contracts you are trading. This is a critical factor because it determines how much you are risking per trade and how much each price movement (e.g., 1 point or pip) is worth. For example, if you are trading with a size of 1, which is worth €1, then every point movement will result in a profit or loss of €1.
Examples:
- 1 size = €1 per point
- 2 size = €2 per point
Margin:
Margin is the amount of capital required to open a position. When you trade with margin, you are borrowing money from your broker to trade a larger position than your available capital allows. The broker requires a certain amount of margin as collateral to cover potential losses.
- If you are trading €1 per point with leverage, your margin requirement may be much lower than your actual position size.
Example:
- Trading €1 per point with a position size of 1 might require a margin of €1,000 (depending on leverage and market), but the potential profit or loss will be based on the total value of the position.
Here is IG’s definition of margin requirement.
Money Management: What is it and how does it affect performance
Money management is the practice of managing risk and optimizing returns in your trading account. It is a key element of all trading strategies and plays a crucial role in long-term success.
Position Size:
Position size should be determined by the risk I am willing to take and the distance to my stop-loss. Larger position sizes increase the potential profit but also increase the risk.
Leverage and Margin Use:
Using too much leverage can lead to quick profits but also larger losses. Proper money management means using leverage cautiously.
Effect on Performance:
Good money management ensures that your account grows steadily without exposing you to excessive risk. Poor money management, on the other hand, can lead to large drawdowns or even the loss of the entire account. Risk management controls emotional trading and reduces the impact of losses while allowing for consistent growth.
How we calculate the percentage monthly return
We use the components described in previous sections. So, we use Margin (the margin requirement) + Drawdown (from backtests) = "Starting Capital." Each algorithm has a drawdown, which is the maximum historical decline, and the figure comes from the backtest.
The monthly return is then calculated in euros / starting capital, giving a percentage figure. This is how we calculate monthly returns as a percentage. We only include data from the past 12 months to fairly compare all algorithms.
Currency exchange occurs between our Swedish and English pages, and we have a fixed exchange rate calculated at 1€ = 11.32 SEK. Although it may change in reality, we have chosen to keep it simple for understanding. The percentage calculation is always done in euros, so the result is consistent across both the Swedish and English pages.
We would also like to note that "starting capital" is not something we recommend. It must be specified for calculation purposes. We do not want to influence how you use your algorithms in your account.
How we calculate margin and CAGR from backtest
Margin Calculation: (How much money do you need for a certain position size?)
Margin requirements vary depending on leverage and the asset being traded. To calculate margin:
- Visit IG's website and input the position you want to use for a particular market. The margin requirement will then be displayed.
Example:
For US Tech 100 (€1) with a position size of 2.4, a margin of 26,352.96 SEK is required to open that position. Note that margin requirements change depending on the price of the underlying asset.
CAGR (Compound Annual Growth Rate) from Backtests:
CAGR measures the growth rate of your capital over a specific period.
Formula:
CAGR = [(Final Value / Initial Value) ^ (1 / Years)] - 1
Example:
- Starting capital: €10,000
- Final capital after 3 years: €20,000
CAGR = [(20,000 / 10,000) ^ (1 / 3)] - 1 = 0.2599 = 25.99% CAGR
CAGR helps to understand the average annual return you can expect from your strategy over the backtested period. In our backtests, we use a starting capital that is 2 times the drawdown from the backtest.