How To Calculate Risk And Lot Size In ForexKehinde LAWAL
Position Sizing is about managing risk and choosing the right lot size. The usual leverage used by professional forex traders is 100:1. What this means is that with $500 in your account you can control $50K. 100:1 is the best leverage that you should use.
The most important thing is how much of your account equity you are willing to lose on a trade. If you are willing to lose 2% of your account equity on a trade this translates into a $10 for a $500 account, $20 for a $1000 account and $200 for a $10K account. This is known as the percentage risk that you are willing to take.
Risk and leverage are different things. Most people confuse leverage with risk. In the answers below someone said leverage is not important it is the lot size that is important. This is partly true. Actually what is important is the Risk Percentage that you choose for your account. Then you translate that Risk Percentage into Lot Size using the Leverage that you had chosen for your account plus what is your Account Equity. Let me explain how.
When we open a trade we decide how much risk we are willing to take. Lot size is determined by the stop loss size. Suppose you have a trade setup. The stop loss is 30 pips. We need to translate this 30 pips into the lot size. This depends on how much risk you are willing to take. Suppose you are ready to lose 2% of your account equity on this trade. This means if you lose 2% of $500 you will lose $10, so you will end up with $490 in your account in case of a loss. If you are willing to lose $10 on this trade you choose 2% risk level. So you will trade with a lot size of 0.03. With this lot size if you lose 30 pips, you will lose $9. And if you trade with a lot size of 0.04, losing 30 pips means you are going to lose $12. So the lot size should be somewhere between 0.03 and 0.04. Metatrader 4 does not allow 0.035 lot size. So either choose 0.03 or choose 0.04.
This is how you are going to calculate the lot size:
$Risk= %Risk*Account Equity/100
Lot Size= $Risk/(PipValue*SL)
In this formula, %Risk is the risk percentage that you chose which was 2%. $Risk is this risk translated into dollar terms. So with the first formula you calculate $Risk. We have %Risk as 2% and Account Equity as $500. So:
Our stop loss is 30 pips. PipValue for a 100:1 leverage account is 1 pips is equal to $10. So PipValue is 10. Now we use the second formula and calculate the Lot Size:
Lot Size= 10/10*30=0.033
As said above MetaTrader allows either 0.03 or 0.04. So choose either 0.03 in which your $Risk will be $9 or choose 0.04 in which case your $Risk will be $12.
Now suppose your leverage is 50. In this case $Risk will be:
This is same as before. %Risk and $Risk does not depend on leverage at all. It only depends on your account equity. You must have understood it by now. PipValue will be $5 as 1 pip will be equal to $5 now. So Pip Value is what depends on the Leverage that you choose. Now lot size will be:
So we can choose either 0.06 lot or 0.07 lot now. You must have observed now that by reducing the leverage you have doubled the lot size. But the net effect is the same. Whether you choose 100:1 leverage or 50:1 leverage, you are going to lose $10. So it doesn’t matter what leverage you choose. It all depends on the risk percentage that you are willing to lose. From that risk percentage you calculate the lot size which depends on the leverage that you chose for your account.
Now this Pip Value thing depends on the currency pair you choose to trade. For pairs with USD as the base currency like GBPUSD, EURUSD, NZDUSD, AUDUSD it is easy to calculate. It is $10 for 100:1 leverage. If you half the leverage Pip Value also gets halved like $5 for 50:1 leverage. If you double the leverage to 200:1, it will double to $20. But for cross pairs like GBPNZD, EURGBP, AUDJPY, NZDJPY it is different. You should use an online pip value calculator for these pairs.