As you can see, if you lose 10% of your trading capital, you’ll need to earn 11.11% to get back to breakeven. If you lose 50% of your capital, you’ll need a 100% return to get back to breakeven. And if you hit a drawdown of 90%, you’ll need a return of 900% before you break even (good luck with that).
The secret to risk management is to lose small when you’re wrong so you never hit a level of drawdown that’s impossible to recover from. That’s why you want to risk a fraction of your capital on every trade (my suggestion is not more than 1%). This means if you have 20 losing trades in a row, your drawdown will be about 20%. This won’t be the end of the world, and you can still live to fight another day.
Now the question is, how many units do you trade if you only want to risk 1% of your trading account? Here’s the formula for forex trading:
Position size = Amount you’re risking / (stop loss * value per pip).
Let me give you an example:
- You have a trading account that’s worth $10,000 USD and you risk 1% on each trade (which is $100).
- You want to short GBP/USD at 1.2700 because it’s a resistance area.
- You have a stop loss of 200 pips.
- Value per pip for 1 standard lot = $10 USD/pip.
Plug the numbers into the formula and you get: Position size = 100 / (200*10) = 0.05 lot (or five micro lots) This means you can trade five micro-lots on GBP/ USD with a stop loss of 200 pips. And if it hits your stop loss, the loss on this trade is $100 (which is 1% of your trading account), excluding slippage.
Here's an example:
For download Forex position sizing calculator for free click here.