Not only newbie demo traders but also the veterans of the live account trading wish to know how to avoid major financial losses and win Forex contests.
Every trader can personally establish the allowable risk threshold. And we are going to show you how to master the art of risk management and choose a suitable risk.
There are three risk determination approaches.
1. Conservative (1‒2% risk). In this case, the risks will be minimum but there won’t be a quick surge in profits either. 2% risk is considered to be a solid choice for those who are only learning the ropes of the risk management system.
2. Moderate (3‒5% risk). This is a perfect approach. In contrast to the conservative method, the risks here are small, whereas the odds of profits are higher.
3. Aggressive (5–20%). This approach is perfect for traders who wish to make maximum profits in the shortest time possible. If you are a newbie, you must be extra careful when using this technique.
There are traders who do not use stop-loss orders at all. Do not rush to mimic that behavior as this trading approach is a recipe for disaster and major losses.
Risk calculation starts with the ability to place stop loss correctly. It should be at a level upon reaching which it becomes clear that the trade forecast was inaccurate. So, you should place your stop-loss orders based on the market environment and not a desired amount of risk.
As soon as you know the size of the stop loss in pips, it’s important to calculate the trade entry volume in such a manner that the risk for it in monetary terms doesn’t exceed 1% of the deposit. Even better if it’s less than that. The risk percentage per one trade is calculated based on the expected value of your trading strategy.
Any system, even the most profitable one, can generate both winning and losing trades. However, thanks to the risk/reward ratio per trade, as well as the number of profitable and unprofitable positions overall, it can lead to a positive outcome.
PLEASE NOTE:
If you wish to calculate the maximum allowable percentage of profit per trade independently, calculate the largest number of losing positions in a row that your trading system can generate, and make sure that this total value of stop-loss orders is not more than a half, or better - more than one third of your trading deposit.
Divide one third of the trading deposit by the number of losing trades in a row and you will learn the maximum allowable percentage of profit per trade.
So, now we know the size of the stop loss in pips and maximum allowable risk per trade in percentage terms. Based on these parameters, we shall calculate the trade entry volume.
It’s also important to factor in the size of your broker’s leverage. Keep in mind that the terms of the marginal trading allow you to increase the lot in case of a small deposit, but at the same time this increases the risks respectively.
Let’s start off with the calculation of the amount of money in deposit currency that we invest when opening the trade. If you are trading forex, the lot size for a number of currency pairs is 100,000 units of the base currency. It can reach up to 150,000 units for other pairs. In other words, 1 lot in EUR/USD pair totals €100,000. Therefore, here’s what we get: 0.1 lot = 10,000 units of base currency, 0.01 lot = 1,000 units of base currency.
To understand how much money you invest when buying, say, 0.01 lot for EUR/USD, you need to convert €1,000 into dollars at the current rate of the currency market.
If the current EUR/USD quote is 1.23, you will need 1.23×1 000 = $1,230 to buy 0.01 lot.
This amount is vital since we shall rely on it when calculating money management and not the size of margin you see in the MetaTrader 4 and MetaTrader 5 trading platform. Basically, margin is the minimum amount that a trader needs to have in the trading account to be able to open a new position.
It is calculated in the following manner: Margin = Invested Amount/Leverage. If you are trading 1:100 leverage, 1230/100 = $12.3 will be used for margin when trading 0.01 lot in case of the EUR/USD pair.
Ideally, the value we include in a trade should be subtracted from the deposit amount before calculating the risk. This works when we are dealing with a small trading account and a very conservative trading approach.
The next thing we need to know is the pip value. Typically, in terms of EUR/USD, GBP/USD, USD/CHF pairs, it is $10 for a standard lot. As far as USD/JPY goes, it floats and is normally less than $10. In case of AUD/USD, NZD/USD and USD/CAD pairs, it is $15 for a standard lot. When it comes to the cross rates, the pip value is a floating one.
To know it whenever you enter the trade, you can install the Tick Value script in MetaTrader 4 which will demonstrate tick value automatically. Having all of the aforementioned data and values, we can calculate the trade entry volume. We are going to use EUR/USD as an example to illustrate this. Let’s assume that stop loss is 50 pips, while the amount in the trading account is $2,000.
We keep in mind that our ideal risk per trade should be 1%; however, the maximum allowable threshold can be up to 3%. It will be about $20-60 in the deposit currency. Pip value is $10 for the standard lot, with 1:100 leverage.
Risk per trade when entering with 1 lot will be 50 pips×$10 = $500. Next, we shall calculate the lot size using the following formula:
Thus, we can enter this trade with 0.04 lot.
Using the similar approach, we can calculate risk for other instruments as well.
To automate this process, be sure to use Trader’s Calculator. You can either find it on websites of the brokers or create your own in Microsoft Excel so that it is geared towards currency pairs that you trade.
But what if the calculated lot size turned out to be smaller than the one that is technically possible for your account? If the difference isn’t huge, while the risk/reward ratio is quite appealing and the entry point is potentially profitable, you can increase the lot size to the level of technically possible one.
PLEASE NOTE:
If the required lot is significantly different from the minimum lot in your account, you should not change the stop loss value, as you may get kicked out, whereupon the price will move in your direction. It would be a shame to incur losses like that. So, in this scenario, it makes sense to skip this entry point and wait for a better one.
Learn how to place stop loss here.
Only those who take trading seriously can actually win the Demo Account Contest and start a career as a managing trader to be able to attract investors, increase their trading deposit and capital. An accurate calculation of trades is a key to success.
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