As mentioned in the previous lesson, the risk in terms of percentage should always be the same. The amount of money that this percentage equates to, depends on the total account balance of a trader. The risk involved in every forex transaction is a function of the lot size used on a particular trade. Therefore, I am going to provide an example which will help you understand how to calculate the appropriate lot size and risk every time you participate on the forex market.
Example of lot size and risk calculation
Let’s assume we have an account balance of $20 000. The components needed to compute the correct lot size are; the amount of money we are going to risk (and the currency of our account), the stoploss in pips, the pair we will trade, and the exchange rate between our account’s currency and the quote currency of the pair we will execute on. 1% risk on a $20 000 account translates to $200 risk per trade. The stoploss for the EURUSD sell position will be 20 pips (measure the amount of pips from your entry price to your stop loss price using the ‘ruler’ tool on TradingView). Having clarified all the required variables, the first step is to calculate the amount of Dollars we want to risk per pip. To do this, we divide the amount we are willing to risk on the trade, by the stoploss in pips, specifically $200 / 20 pips = 10 $/pip. We mentioned in our lot size lesson that in order to compute the monetary value of a 1 pip movement on a trade, we need to multiply the lot size by 10. When calculating the correct lot size, we need to do the reverse. Knowing that our pips should be worth 10$ each for the EURUSD short position we are planning, we can divide this value by 10 to find the lot size. (10$/pip) / 10 = 1 , therefore if we want to risk 1% of our $20 000 account on a EURUSD short position with a 20 pip stoploss, the lot size we need to use is 1.00 (Standart). The same would apply if we were buying EURUSD, the direction of the trade is irrelevant in the calculation of our position size.
The importance of the trading account currency
For simplicity’s sake, the currency of our account is the same as the quote currency of the pair we are trading (USD) in the described example. If our account currency is different to the 2nd currency of the pair we will trade, which occurs often, there is one more step to this calculation. Let’s change one variable in our example to gain a better insight of this process. Instead of shorting EURUSD, we are willing to buy GBPAUD. In this layout, the first step to calculate the lot size is now converting the amount of money we are willing to risk from the account’s currency (USD) to the quote currency of the pair we want to trade (AUD). To do this, we need to multiply the amount of Dollars we are going to risk by the current USDAUD exchange rate. Assuming the current rate of AUD per USD is 1.5, the amount we will risk in this hypothetical trade is exactly $200 x (1.5 AUD/$) = 300 AUD. Having found this, the rest of the steps are identical to the route we followed before.
AUD 300 / 20 pips = AUD 15/ pip
(AUD 15/pip) / 10 = 1.5
Conclusively, the lot size we want to use in the EURAUD is 1.5. The path of this calculation is relatively simple, but it may be tedious and time-consuming when applying it practically on the market. I have a solution for you. You can utilise our lot size calculator which will simplify the process of risk management for you. All you need to do is fill in the required variables, as discussed earlier (Account currency; Currency pair; Account size; Risk ratio/amount; stop-loss in pips), and the algorithm will calculate the recommended lot size for your trade