Risk Management Primer

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It is simple: you need to protect your money, and you are not going to get rich overnight. The temptation of Forex is that the insane leverage offered, as well as gambler's math, leads almost all new traders to think that they can turn $100 into $1,000,000 in one year. Theoretically this is possible... but then again, theoretically it's possible you'll hit the lottery. The odds are about the same (actually, your odds of hitting the Mega jackpot or the Powerball are probably better). In reality, growing your taco money to seven figures in one year DOES. NOT. HAPPEN. Inherently, you need to have a system of risk management that involves stop loss usage and a formula to calculate position size. The rookie error is to think the following:


(ACCOUNT SIZE) x (MAX LEVERAGE) = POSITION SIZE.


DO NOT DO THIS. You will lose everything, and likely not be able to recover... this is gambling. Instead, stop size and risk allowance determine position size.

The general rule is that you should risk 1-4% of your account on any given trade. Now, you can leverage the entire amount, but your stop should reflect 1% of that. How to calculate this? Use this formula:


(ACCOUNT BALANCE/100) / (STOP LOSS IN #OF PIPS) = (POSITION VALUE)


"Position value" is going to be a dollar number... which you then use to figure out how many lots/mini lots/micro lots your position will be. In order to do this, you need to use a "pip calculator" which most brokers will provide on their site. In the first bracket, you divide by 100 for 1%, 50 for 2%, 33 for ~3%, and 25 for 4%.

EXAMPLE: you have a $1,000 dollar account. You are placing a trade on EUR/USD. Your analysis determines that your stop is 20 pips. X is position value.


(1,000/100) / 20 = X
10 / 20 = X
0.5=X


What is 0.5? The value per pip of your position. Looking at our calculator, this shows us a position of 5,000 units. This means that you are using 5:1 leverage on your $1,000 account. This won't sound appetizing at first ("Hey man, I can leverage 50X and get 10x the reward!")..... but then again, losing your whole nest egg in one shot should sound stomach turning as well.