Updated: Sep 28, 2021
A lot of new and intermediate Forex traders blow their accounts in a matter of weeks and blame it on their brokers, or a faulty strategy they found online, fundamentals, or market volatility among others.
However, they forget one important aspect why they keep on burning their accounts -- Proper Lot-Sizing.
In this blog, I will share how I compute proper risk per trade or how much lot size you should be using for each trade position.
But first, how much is the proper amount of risk that we should use per trade?
I've seen a lot of traders risk 10% of their account balance per trade. This is way too much risk. Let's take an example where a trader has $1,000 on an FX trading account. Should this trader lose trades 5 consecutive times, which is very much possible and even happens to professional traders, then 10% risk per trade x 5 losing trades = 50% loss on the account. The account is thereby reduced to $500. The trader very much killed the account. We didn't even consider the leverage used at this point. I know for a fact that new traders are notorious for using excessive leverage from 1:200, 1:500, or even 1:1000. There's really nothing bad about these leverage levels, but we all know newbies still don't know how to properly make use of leverage.
Time and time again, I have to drill this down to you that the most important thing in trading is not the profit you gain, but the preservation of the capital that you put in. Profit is the secondary result of good risk management.
Now, let's do this properly this time. A good trader would always trade with reduced risk. Let's go back to the same $1,000 example earlier. This time, we're going to use 1% risk per trade. Should the same trader lose 5 times in a row, his account is there by reduced by 1% x 5 losses = 5%. This means that the $1,000 account less 5% loss is still standing at $950. In this case, we can all agree that this is a much better picture than the first example. It will also be more manageable to recover these losses using the same risk per trade.
How to compute for the proper lot size?
Here is a simple computation I use every time I trade
Account balance = $1,000
Risk per trade = 1%
Stop Loss in pips = (determine this for each trade)
Risk-to-Reward ratio = 1:2 (your choice)
Let's take a trade example, say we're trading the EUR/USD. We have $1,000 in our trading account. We've identified a potential trade based on our strategy. We also plan to have a 35 pip stop loss and a RR of 1:2
Lot size = Risk% x Account balance
Stop Loss in pips x 10
= 0.01 x $1,000
35 pips x 10
Lot size = 0.0285 (you can choose to use 0.02 lots)
To compute for the value of each pip you earn, you simply need to take the risk size for this trade which is 1$ of $1,000 = $10 and divide this number by the number of pips you risked for the trade. (35 pips)
If we do the math, that's $10 / 35 pips = $ 0.285 per pip.
So, each pip you earn from this trade will give you $ 0.285 of profit. If you have a 1:2 Risk-to-Reward ratio and expect to gain 70 pips, then you simply need to multiply $0.285 x 70 pips and your expected profit for this trade is about $20.
In conclusion, by using a reduced lot size, you are better able to manage risks and significantly decrease the chances of blowing your trading account.
Yes, I know, the profit in this case is not what you have expected. Well, as soon as you have mastered risk management and have properly back-tested and forward-tested your strategy on a demo account, you can then be more confident to add more money into your trading account. Finally, using the power of compounding interest, you can take advantage of this to further increase your gains.
The bottom line is, you are able to manage risks much better, you're not putting your trading account at excessive and unnecessary risks, and you will least likely be affected psychologically if you lose a trade since you are only risking a small percentage of your trading account.
This is how to survive in the markets. Remember, this is not a get-rich quick scheme. Trading requires tons of patience, study, correct psychology and MONEY.
For more information on Risk Management, visit my website at www.hivefxsignals.com/mentorship
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