As early in your Forex career as possible, you must make the minimization of losses your number one trading priority. In addition, you should also realize that using excessive position sizing will be your number one enemy. Basically, you must strive not to over-trade by risking too much of your equity per position.
For instance, what would be your answer to the following question? If you had equity of $ 5,000, how much of it would you risk on your next trade? Here are a couple of the main answers collected by a recent survey: –
1. Many traders replied, 'I would risk about 50% because I would still have the other half left if I lost'.
2. Another response was 'I would trade 25% because if I had to end 3 consecutive losses then I could still recover'.
However, these replies clearly demonstrate that many traders do not understand that their losses can compound so quickly that their account balances can be obliterated. You must never forget this very important point.
For example, imagine that you risk 50% of your entire $ 5000 budget on one trade and lost. You would have $ 2500 remaining. You will now need your next position to return a 100% profit in order to just break even and recoup your losses. In summary, each time you endured a 50% loss, you then require a profit of 100% just to recover.
If you suffered two consecutive 50% losses, your remaining equity would then be $ 1,250. You now need a 400% profit from your next trade just to achieve parity. You must never forget the impact on your equity if you resort to using excessive position sizing.
You must keep the following concept at the front of your mind whenever you are trading: a loss always requires a bigger win to recover. You will enjoy more success trading Forex if you base all your trading actions about this concept. What is a good risk level? To answer this question, consider the following example.
Suppose you decided to risk 10% of your equity on each position that you opened. If you then endured 10 consecutive losses, you would have just about one third of your account left. If, however, you restricted your risk to 2% per trade, then you would still have about 82% of your original equity remaining should you suffer ten consecutive losses.
Obviously the second case produces a far improved level of protection for your equity against the threat of compounding losses. You should be able to confirm that this is why experts advise that you never risk more than 2% of your total equity per trade.
You must always appreciate the serious dangers of over-trading and, consequentially, guarantee that you select position sizes for each of your trades so that you do not risk margin calls. From the above analysis, you know now that you will require a substantially larger win to recoup your original equity after each loss.
You may deduce from the above study that you may need to take a significant time in order to amassing any serious profits if you resort to risking small amounts per trade. However, this would be a wrong conclusion because you will be able to compound the profits associated with your wins, your equity will grow exponentially.