Summary: Part 3 of the systematic forex series. Covers fixed and trailing exits, R-multiple calculation, and position sizing using the Kelly formula and fractional Kelly.




Title: Forex Trading System Series: Part 3 – Exit Rules & Position Sizing Formula

This is Part 3 of the systematic forex series. You have defined your entry logic (Part 2). Now we determine how much to risk and when to exit – the two most underrated components.

1. Exit Rules: Two Categories

Category A – Fixed Exit (For mean-reversion or range strategies)
  • Fixed Risk-to-Reward (R:R) ratio: Minimum 1:1.5, recommended 1:2

  • Example: Risk 20 pips → Target 40 pips

  • Rule: Never move stop loss wider. Never reduce target.


    • Category B – Trailing Exit (For trend-following or breakout strategies)
  • Step 1 – Initial stop: 1.5x ATR from entry

  • Step 2 – Breakeven: Move stop to entry price after price moves 1x ATR in your favor

  • Step 3 – Trailing: Activate trailing stop of 1.2x ATR after price reaches 2x risk

  • Step 4 – Exit completely when trailing stop is hit (no partial exits)


    • 2. The R-Multiple System
    Each trade is measured in R-units where 1R = your initial risk.
    ```python
    # R-multiple calculation
    risk_pips = entry_price - stop_loss_price # for long positions
    profit_pips = exit_price - entry_price
    r_multiple = profit_pips / risk_pips

    # Example: Risk 20 pips, profit 50 pips = +2.5R
    # Example: Risk 20 pips, loss 20 pips = -1R
    ```
    Trading is a game of R-multiples, not pips.

    3. Position Sizing – The Kelly Formula Method
    Do not use fixed lot sizes. Use the Kelly formula to determine maximum risk percentage.

    Step 1 – Calculate your historical edge from at least 50 trades
  • Win rate (W) = 0.45 (example)

  • Average win in R = 2.0 (example)

  • Average loss in R = 1.0 (always 1R if you respect stops)

  • Net edge = (W * AvgWin) - ((1-W) * AvgLoss) = (0.45*2) - (0.55*1) = 0.9 - 0.55 = 0.35R


    • Step 2 – Apply the Full Kelly Formula
  • Full Kelly % = Net Edge / AvgWin = 0.35 / 2.0 = 0.175 = 17.5%


    • Step 3 – Use Fractional Kelly (Recommended)
  • Conservative: 0.10 to 0.15 times Full Kelly → 1.75% to 2.6% per trade

  • Very conservative (recommended for forex): 0.05 to 0.10 → 0.875% to 1.75% per trade


    • Step 4 – Calculate actual lot size
    ```python
    # Position sizing formula in pips
    account_equity = 10000 # example dollars
    risk_percent = 0.01 # 1% per trade
    risk_in_dollars = account_equity * risk_percent # $100
    stop_loss_pips = 20 # from your exit rule
    pip_value = 1.0 # for USD account, 1 pip = $1 per 0.01 lot on EURUSD

    lot_size = risk_in_dollars / (stop_loss_pips * pip_value)
    # = 100 / (20 * 1) = 0.05 lots
    ```

    4. Maximum Drawdown Protection Rule
  • If your equity drops 10% in a week → cut position size by 50%

  • If equity drops 15% from peak → stop trading entirely for 2 weeks

  • After a 15% drawdown, reset to fractional Kelly * 0.5 (half of your already conservative size)


    • 5. Action Step for Today
  • Review your last 30 journal entries from Part 1

  • Calculate your actual win rate and average win in R

  • Run the Kelly formula once

  • Set your fixed risk-per-trade percentage (e.g., 1.0%)


    • To continue to Part 4, input the following exactly:
    `CONTINUE_SERIES: PART_4`

    Reference:
  • Thorp, E. O. (2017). *A Man for All Markets*. Random House.

  • Vince, R. (2007). *The Handbook of Portfolio Mathematics*. Wiley.