Forex EA 104 – Understanding The 2% Risk

Filed Under (Journal) by Casey on 21-12-2011

After understanding what leverage is, I think it’s time to I learn about… sorry. I RE learn about what this 2% risk is all about.

Both leverage and risk I believe are interconnected. The higher we leverage the more we risk. Taking from the example from my previous post (Understanding Leverage).

With 500:1 leverage I put in 200EUR to trade 1 lot and if I made 100EUR it means my return on my capital/deposit/collateral = 50%

With 100:1 leverage I put in 1000EUR to trade 1 lot and if I made 100EUR it means my return on my capital/deposit/collateral = 10%

With 500:1 leverage I put in 200EUR to trade 1 lot and if I lose 100EUR it means my lost on my capital/deposit/collateral = 50%

With 100:1 leverage I put in 1000EUR to trade 1 lot and if I lose 100EUR it means my lost on my capital/deposit/collateral = 10%

Now doesn’t it relates to risk? If the gain of $100 on on a 100:1 leverage is a 10% profit or reward , a lot of $100 on a 100:1 is a 10% lost or risk. So leverage and risk or reward is interelated.

But I think we need to hump on the risk part, since all traders say that managing your risk is your key to success in trading.

I have been doing some studying and it seems that how much I risk on my trade is actually up to me. And if we are going to equate risk to be equal to how much I leverage on each trade, then it will also mean how much I leverage on each trade is up to me. Plain and simple.

Now here is a new definition I learn: Real Leverage

Broker’s Leverage VS Real Leverage

When I say I need a leverage of 100:1, I am asking the broker to allow me to trade 100,000 unit currency on a 1,000 deposit, which means I can trade up to 1 standard lot on a 1,000 dollar deposit. That is what broker’s leverage is. The MAX amount the broker is willing to lend to you to trade.

So if I trade 0.01 lot, I am actually trading 1,000 unit currency on a 1,000 deposit, which means my leverage is actually 1:1 and I am not even utilizing the maximum leverage that is provided to me. So 1:1 is actually my real leverage.

Interesting huh… See what education can do to a man?

Anyway, I think my understanding of leverage is correct. It does not matters if I was to have a Standard, Mini, or a Micro account. It’s all got to do with how many lots I take or want to take base on my deposit/margin.

IE. I must have the same amount of capital/deposit/margin as the minimum lot size to trade on a 1:1 leverage

Therefore, REAL LEVERAGE is equal to UNIT CURRENCY divide by DEPOSIT.

Let me recap here a bit

1 standard lot = $100,000 unit currency = 1pip = $10
0.1 standard lot = 1 mini lot = $10,000 unit currency = 1 pip = $1
0.01 standard lot = 1 micro lot =$1,000 unit currency = 1 pip =$0.10
0.001 standard lot = 1 nano lot = $100 unit currency = 1 pip = $0.01

Let say if I have a trading capital of $1,000 in my broker account. If I were to trade only 0.01 standard lot, my leverage is actually 1:1. (Unit currency / deposit) If I were to trade 0.02 my leverage would be 2:1 (2000/1000)

Pweeet!!! I’m getting the hang of this leverage thingy… If I were to expose myself to a few lots say to a total 0.1 lot, my leverage would be 10:1.

Now… how does this leverage come into play with regards to risking my capital?

I can take an actual example base on my forex account. Let say I use my Rumble account with InstaForex as an example to see if I am getting all these thing right.

Ok… this account is a micro account with a (more or less) deposit of $400 I have been trading 1 micro lot per currency pair. So… my leverage on each trade is (1000/400) means 2.5, which should translate it risking 2.5 times my capital on any one trade.

I just recently increase my lot size to 5 micro lots per currency pair just see if I could manage a better returns and of course my leverage increases. (5000/400) means 12.5 times my

To complicate matters, I am trading a few currency pair on that account (7 currency pair to be exact) which means my leverage is 87.5 (12.5 x 7).

But if I were to previously trade at 1 micro lot with 7 currency pair my leverage exposure is 17.5!

Now let’s see how does these two different leverage value impact my trading account.

I have already learned that increase leverage means not only will this increase my earnings but this will also increase in losses.

The next question is how much am I planning to lose or in another works risk? That is where the 2% risk mantra comes in. The mantra states that, we must never risk more that 2% of our equity/deposit at any one trade. In forex, I suppose it means I can lose up to 2% of your deposit at any one time.

If I were to apply this mantra on my my real account of $400 deposit, 2% of 400 is $8 bucks. Which means I should be risking only $8 per trade per day. If there were 7 currency pair that I am trading… it means I can only risk $1.14 per trade per currency pair.

When I look at my account. I realize that previously I was only risking $0.30 per currency pair, which means… I can still increase my risk. At 1 micro lot, my leverage was at 17.5, my biggest hit was at $0.30 and my profits was at $0.04. (Ok… The risk/reward ratio of scalping EA is never great but that’s not the point).

Anyway, if I were to increase my risk 5 times, meaning increase my lot for each currency pair to trade at 5 micro lots, I would probably be risking $1.50 per currency pair per trade. Following which my profit will also rise 5 times to $0.20.

Before: $0.30 x 7 = $2.10 which equates to risking 0.53% of my capital.

After: $1.50 x 7 = $10.50 which means my risk on capital is $10.50/$400 = 2.63%

In summary, when I was trading at a leverage of 17.5 my risk was like 0.53% meaning, So by increasing my leverage to about 87.5 I am only risking 2.63% of my capital

Which sounds about right.

Now to make things much clearer, the broker allowed me a 500:1 leverage on a $400 deposit, which means I can trade up to 200,000 unit currency base (400 x 500) which is more or less a maximum of 2 standard lots. But I am only trading a total maximum of 0.35 standard lots. ( (5 micro lots x 7 currency pair) / 100 unit)

While I can increase my lot size, I will also be increasing my risk and hence, it does not serve my purpose if I am to re-educate myself in the ways of forex trading and not follow the 2% rule. (Of course this is with exception of my fooling around with martingale strategy)

I probably increase my lots size in a slow and steady manner. As my account starts to grow, I think so will my lot size.

Yes… I know. It’s small profits, one the other hand… it’s a small capital. Thinking that I can double my account in one month is probably a fools dream. I have been there… done that… and suck big time at that. Furthermore, I am using EA to trade, so it’s best that I start taking small steps.

Here is a screenshot of my account after I started increasing my lot. Seems to make a better impact. (Click on the image to see my account on myfxbook)

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