How To Manage Risk Through Proper Position Sizing?
Once you are into Forex Trading, always think about your downside, meaning how much can you lose per trade?
It is not really how much you can earn from the Forex market but is how long can you stay in the game for the long haul and to remain consistently profitable. Thus you must always plan for your downside if you are wrong about your trade or the market has decided to move against you.
For most of the other Forex traders out there who do not think about their downside, i.e. by never putting stops in their trades, it is a sure guarantee that these traders will suffer a big loss or even lose all their previous winnings as well as their capital sooner or later.
Therefore, in order to become a successful Forex trader, you must have the habit to set three important prices for every trade that you go in. The three important prices are entry price, stop loss price and take profit price.
Without these three prices, it will be impossible to execute the money management process, which is extremely crucial for any Forex traders out there.
So what is money management all about?
It is all about how you decide how many lots to trade in any single trade, how much money you intend to risk and how you exit from a trade, be it taking profits or hitting stop loss. The decision must not be based on your instincts or emotion else you will be seeking for self destruction.
Take for instance, if your starting capital is $10 000 and you are now trading EURUSD currency pair.
As a rule of thumb, never risk more than 3% per trade as recommended in most Forex books.
Therefore, you are prepared to lose 3% of $10000 = $300 per trade.
Based on your strategy, you should have the entry price, stop loss price and the take profit price beforehand else it is not a very good strategy. If my entry price to the stop loss price is 30 pips and per pip is US$10 for EURUSD, therefore the total amount to lose based on your strategy will be 30pips x US$10=US$300.
The number of lots that you can trade = Prepare to lose amount / total amount to lose based on your strategy
= 3% x US$10000 / US$30 x10
= 1 lot
As such, if the trade goes against you and stop you out at the predetermined stop loss price based on your strategy, you will only lose US$300 based on that 1 lot size. And you can still survive inside the market and fight another day.