Remember To Control Your Risk

20 Jan 2010

Trading is about risk management first and then on making money. To make money, you must continue to lose control. This means that you reduce the amount you risk of each trade a "reasonable" amount.  To do this, you should use a stop loss order.  As a rule of thumb (do not you love that?), You should not risk more than 5% of your account value on any one trade. Let's do an example to drive this point home. Let's say you open an account with $ 10,000 and your broker margin requirement is 1%. As usual currency traded in lots (or pieces) of $ 100,000 (1 lot = $ 100,000), this means that for every $ 1000 in your account (1% of $ 100,000), you are able to trade 1 lot of $ 100,000. This also means that a $ 10,000 account, you can trade a maximum of 10 Parties ($ 1000 for each party). In real life, this amount of trade much is too risky. Let us use the equation to see why:  Max Lots = (Acct Size x% loss) / Stop Loss Price Let's assume that your% loss (or the maximum amount you are willing to risk per trade) is 5% and that your stop loss is 10 pips, or $ 100 (usually very active traders set a stop from 5 to 10 pips):  Max Lots = (10,000 x 0.05) / 100 = 5 plots This means that 10 lots is two times the maximum amount of lots you should trade. Even though I'm like 5% rule of thumb, in reality less this is even better. The lower the figure, the longer you remains in the game. If we would have done the above example with 1% (an amount commonly used by traders strict) instead of 5%, the maximum number of parties would have been 1 instead of 5.