Along with a forex trading system, one of the things you will need to trade FX is a money management system. This requires you to figure out how much you should risk on each of your forex trades.
Here are some examples of how different traders might decide to structure their risk:
- Risking 2% per trade.
- Risking $20 per trade.
- Risking between 1-3% per trade depending on certain variables.
- Using the Martingale system.
This post will help you figure out which of these approaches makes sense and why.
Should You Risk a Fixed or Changing Amount?
First of all, let’s address the question of whether the amount you risk should be fixed or fluid. This question, we feel, has an easy answer: the amount should be a fixed percentage.
If you set your risk at 2% per trade, you should always risk 2% per trade, no more and no less.
Why? Because you are only supposed to take the best setups your system generates. It is not worthwhile to compromise on quality.
If you tell yourself, “It’s okay—I can just risk less when I am less confident in a setup,” what message are you sending yourself?
You are telling yourself that it is okay to take trades you do not feel confident you will win. Clearly, that does not make a lot of sense. You should be doing what you can to not lose trades, even if that means sometimes you have to wait for a better setup.
But What About Progressive Systems Like Martingale?
Some forex traders may think that a good way to manage their risk is to rely on the Martingale system or other progressive systems.
When you follow the Martingale system, you double the size of each of your trades every time you lose.
The reasoning behind doing this may or may not seem intuitive to you. But the idea is that sooner or later, you must surely win a trade. By the time you do, you will have increased your risk to the point where the subsequent payoff should compensate for all the losses you accumulated along the way.
What a lot of people will not tell you about systems like these is that for them to be profitable, you must have an infinite bankroll.
In actuality, the only thing that using a progressive system will do when you are trading is cause you to lose your money more and more rapidly until it is gone.
Should You Set Your Risk as a Dollar Amount or Percent?
So, we have established why you should risk a flat amount on each of your trades, neither increasing nor decreasing that amount. But your next question might be whether it is more suitable to use a set dollar amount or a set percentage.
We suggest that you stick with a percentage. The reason is that it should make it easier for you to increase your account size exponentially.
Imagine that you are starting out with $2,000 in your trading account. If you decide to set your flat risk amount at $40 per trade, you will initially be risking 2%.
Now picture if your account grows to $3,000, and you are still risking $40 on each trade. You are no longer risking 2%. You are now risking a lower percentage. You could risk more responsibly—and profit more—but you are holding yourself back.
A worse problem is what happens if your account shrinks and you keep risking the same dollar amount. Imagine you have had enough drawdown that you now only have $1,000 in your account. If you are still risking $40, you are now risking 4% on your trades. If you keep losing the same dollar amount, your drawdown is going to erode your account more and more rapidly.
You can avoid all of these problems simply by risking a flat percentage on every trade instead.
- As the amount of money in your account increases, so will the amount of money you are risking on your trades. At $2,000, you will be risking $40. But at $20,000, you will be risking $400. You can see how this will help you grow your account. But you will not be risking a larger chunk of your account overall.
- If you have a significant drawdown, you will not find yourself suddenly risking a higher percentage of your account. You will be containing the damage more effectively.
Simply calculate what 2% of your account is before each and every one of your trades to follow this technique.
What is a Good Percentage of Your Account to Risk on Your Forex Trades?
Speaking of 2%, you might wonder why we keep coming back to that. The reason is that 2% is a sensible percentage of your account to risk on each trade you take.
In fact, it is the higher end of what you should consider risking. You might actually want to keep your risk closer to 1%.
So many newbie forex traders think 5% or even 10% is “conservative.” It is not. Losing 10 trades in a row is something that hopefully will not happen often to you, but it is not an unrealistic possibility even with a good system. You do not want to have a losing streak like that wipeout half or all of your account.
We have now given you a thorough answer to the question, “How much should I risk on each of my forex trades?” To sum up:
- You should risk a flat amount on each trade.
- It is best to express that amount as a percentage and recalculate it for every trade.
- The percentage should be very small, like 1-2%.
Money management is truly one of the simplest aspects of trading forex, but it is one that numerous traders get wrong time and again.
So long as you follow the recommendations above, you will be taking a responsible approach to managing your money and protecting your account.