Risk Management and Lot Sizing

Money management is one of the most neglected trading skills of forex trading. The trick is to match your money management approach with your personal trading and risk profile. One has to strike a balance between capital preservation and trading risk.

If you have found a trading technique that is reasonably consistent and profitable (an average of 400 pips per month per annum will do) we would suggest that you consider the following money management techniques:

If you have found a trading technique that is reasonably consistent and profitable (an average of 400 pips per month per annum will do) we would suggest that you consider the following money management techniques:

Always risk the same percentage on each trade.

For example:- a trader (John) has $30 000 in his trading account to trade and has decided to risk 2% on each trade. He has his money in a mini account ($1= 1Pip) for reasons you will see soon. This means that if John considers a trade with a target of 100 pips and a stop of 40 pips (the risk) he would calculate the number of lots he can trade in the following way. 2% of $30 000 is $600. He can therefore risk $600 on his trade. He calculates the number of lots by taking the $600 divided by the 40 pip = 15 lots. Thus if the deals is successful John will earn 15 lots x 100pips = $1500. If the deal is unsuccessful he will lose $600 which is the 2% that was prepared to risk.

If the risk was 45 pips he would calculate the number of lots;- $600 / 45pips = 13.33 or 13 lots. Always round downwards, even if the answer is .9. This also shows the importance of trading mini accounts (1 pip = $1) rather than the main accounts (1 pip = $10). If John was using a main account he would be trading 1 lot for a long time.

Risking the same % on each trade builds in an interesting dynamic. When the trading results a good you automatically increase your number of lots and when trading result are poor you would end up decreasing your lots. A good trading approach in general.

Use the risk approach that matches your personal trading and risk profile.

If you are a conservative investor and the capital you use to trade the forex market is not completely risk capital then you could consider risking 1% (or less)of your capital per trade. This means that over time you would only lose your capital once you have more than a net of 100 negative trades. In general these traders sleep quite well during the evenings. They could still double their account in 8 to 10 months.

If you are a less conservative investor and the capital you use to trade the forex market can be exposed to more risk, then you could consider risking 2% of your capital per trade. This means that over time you would only lose your capital once you have more than a net of 50 negative trades. In general these traders are reasonable secure if they have found a technique that generates an average of 300 per month. They could double their account every 6 to 9 months.

Some more aggressive traders risk 4% of their capital per trade. The risk is higher and therefore they have to have a fairly consistent trading technique. These traders double their trading account a number of times a year. They can effectively, on average, get it wrong 25 times before they loose their capital. After doubling their money, they would often bank their original capital and then use their gains as their risk capital. A nice position to be in because your original capital is secure.