Risk Management per Trade

You have some risk limits set for your account overall and by currency, you should address the separate question as to how much you should risk per trade. Of course, it is OK to risk different amounts per trade, but you should determine this systematically. 

There are several variables that should go into position sizing strategies for Forex traders, but first of all risk per trade needs to be calculated as a percentage of your total account equity. Total account equity can be determined by looking at the amount of realized cash in your account – you should assume the worst-case scenario i.e. that every open trade will be lost. 

There are two advantages of this method as opposed to simply risking the same amount again and again regardless of performance, which is the case when you use a predetermined fixed lot size or fixed cash amount: 

 Forex trading strategies tend to produce winning and losing streaks and not an even distribution of results. Using a percentage of equity to determine the size of each trade means that you risk less when you are losing and more when you are winning, which tends to maximize the winning streaks and minimize the losing streaks. 

You can never completely wipe out your account! Using a fixed lot size or cash amount might wipe out your account, or at least send it into a decline from which it may never recover. 

Here are some of the essentials you should consider in determining how much you should risk per trade: 

- What is the worst performance you might have to suffer, and what would it look like? Could you cope psychologically with a drawdown of 10%, 20%, or even worse? Should you ever be that far in negative territory? 

- How often you trade will also be a factor, as this will impact your worst drawdown. 

- What are your expected winning and losing percentages? Back test your trading. For example, if you have a Forex trading strategy where you plan to lose 80% of your trades but win 10 times your risk on the remaining 20%, your risk per trade should be smaller than if you are planning to make 3 times your risk on 40% of your trades. Of course, if you have a flexible exit strategy, then just make an approximation of how it will probably work over time. 

- Is it possible with your account size to trade small enough? For example, if you have an account of only $100, and you wish to risk 1% per trade, you will have to risk a single penny per pip with a stop loss of 100 pips. This might be impossible, depending upon your broker. However you should capitalize upwards or change your trading strategy instead of increasing your risk per trade if that is the case. 

- Is your account a nest egg or a relatively small amount of real risk capital? If your total net worth is $25,000 for example, and you have an account of $10,000, you might have less tolerance for drawdown compared to an account of $1,000.

Remember that your money management strategy will interact statistically with your win rate and average win size to directly affect your overall win or loss over time. Readmore ...