A very good piece written by an old friend who is one of the best FX traders I know.
Forget about the rewards and doubling your money in one year. Knowing how much risks you are taking ensures you survive long enough to give yourself the chance to make lots of money.
First, decide how much money you are putting aside to trade. It’s the same as setting aside money to set up a business. Let’s say you decide to invest US$100,000. Also, decide how much money you are willing to lose before this business venture folds. I like to use 30 percent.
Next decide how much risk you want to take on every trade. Most traders would put 1 percent as a minimum for any open positions at any one time. This means that you ensure that whatever trade you open, your stop loss or risk is only US$1,000. For a EUR100,000 position against the USD, your stop loss should be 100 pips away. For a 30 percent fall in the initial US100,000 equity, you would therefore have to lose 30 times in a row. This is unlikely but not impossible. If you like to take more risks, bump up the position size but keep the stop loss level similar.
For example, by upping to EUR200,000 and keeping the stop loss to 100 pips, you would take a risk of 2 percent of your capital. Understand however, that 15 losing trades in a row will wipe out 30 percent of your initial capital. For putting this US$1,000 at risk, you should rightly look for rewards in the US2,500 or US$3,000 range, ie 1 to 2.5+ risk/reward range.
Lastly, review your trades over the past months or years to calculate the number of trades you made money on, you lost money on, your average profits and losses, highest drawdown or highest equity levels. What other risks should you be looking out for? 1. Emotions 2 your system does not work on all markets 3 unable to execute trades – eg. Internet connections for bot-trading.
Notice we have not touched on what FX is or how to look for a good trade. That will be for lessons in the future.