Risk management question

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#1

I have read the articles in School and I am getting schooled in Forex but also have read several other books because I think you can learn from other writers perspective. One thing is always on my mind and I am asking here.

Per the article in School-Risk Management it says “try to limit your risk to 2% per trade”. And it goes on to list in a table for $20,000 the 2% risk is $400. My question concerns the $20,000. Is this the direct amount of my cash value (deposit) in my account? Or is this $20,000 with leverage?

For example if I deposited $2,000 in my account with a 50:1 leverage I would have $100,000 in my account. Obviously 2% of $100,000 is going to be a risk to my account of $2,000.

The table listed is showing a list starting at $20,000 but apparently this is NOT leverage because it states a 2% risk per trade comes to $400. How come is the table not mentioning anything with leverage since that is why the majority of traders turn to Forex in the first place…leverage.

To: Jason Rogers - I picked this thread under FXCM because that is where I am going to try my demo account and you see to be active in working with us fellow traders so this is pretty helpful.

Thanks!

#2

What do you know about leverage and it’s direct correlation w/ solvency, from a purely retail-trading-account-perspective?

#3

Accountbalance. It is not related to leverage so it makes sense that it is not converted to leverage amounts. It is just common sense, don’t trade too big or else your account gets blown up, so 2% is just a good advice. And this is not specific FXCM.

#4

Hi Blueridge,

As Toekan has said, the $20,000 figure refers to the amount deposited into the trading account and has nothing to do with leverage.

While 50:1 leverage is the maximum available to forex traders in the US, it would be unwise to use all the leverage available to you. Consider that you may have a car with a top speed of 150 mph. How often would you drive at that speed?

Just as it’s unsafe to drive at 150 mph, it’s dangerous to max out your trading leverage. For more insight on this, I suggest you read this article: Trading Leverage � A Real Look at how Traders May Use it Effectively

I’m glad you reached out to me. If you have any questions about your demo account, please let me know.

#5

In reply to the person who reply to my initial post, leverage is given to us when we open an account because many times with a small pip movement that equates to a small amount of gain. So we use leverage to enable us to trade a larger lot and thus gain more. However with this leverage it can also hurt us in the long run because while leverage can magnify a traders gain it can also amplify a traders loss. This that can cause a traders account to lose more if not completely.

After thinking this more, it makes sense to do the 2% of your Trading Capital and use that amount as a limiting factor so you can account for the possible wild swings and should a loss occur on one trade, you can keep trading instead of getting your account wiped out should you trade with larger trading capital.

To the others, thanks for contribution to this thread. I came from a stock investing background. I am only considering FOREX primarily because you can get in with a much smaller amount but also because the hours to trade in FOREX is more flexible.

#6

Since I plan to start a demo with say 20:1 leverage I think its small enough to start with and get an idea how it works. I presume a person person can set whatever leverage they want to set their actual account with and we can also control the lot size in trading.

Reason for asking in this initial post is to clear up something. As one of my engineering professor said along time ago “No question is stupid if you learn something”.

#7

True, there are no stupid questions. Yes, you can trade 20:1 on a 1000:1 account, but not vice versa.

If you have a stock background you will like forex. :slight_smile:

  • High leverage with a smaller total loss risk (the dollar won’t go bankrupt in a day);
  • No ice-berging to avoid lack of liquidity moments;
  • It will take more than a bad performing CEO to affect the currency rate significantely;
  • 24/5 (24/7 if you look for it) market.

Oh boy, you may even question why you traded stock in the first place. :wink:

#8

That is sound advice, but to level things out. Brokers like you to have all your equity on your account with them. In which case 50:1 is wise. But when you play it right you may consider: "Why put all my equity at a broker when I can keep 50% in my own pocket and trade on a 100:1 account.

The 2% rule applies to 2% of your TOTAL equity that you reserve for forex, not necessarily the equity that you placed on a broker account. You can have 100K with a broker and 400K on your bank account. With high leveraged accounts you are still able to keep money at your bank without limiting your trading, while reducing your conterparty risk.

That would be wise. I am sure that most traders place 100% of their equity with a broker in order to maximize their trading. So I am afraid that Jason’s advice is right in most of the traders.

#9

Toekan,

Thanks for your contributions to my thread and others. I am learning by seeing how others envision working with Forex.

However I want to mention a couple of things. Investing in stock is not truly a losing proposition for many people because if you do buy low and hold a long time this will become profitable for many people. This is why Warren Buffet is very successful (and yes I know he probably gets preferred treatment when he purchases a large block of stock from a company). Not to mention dividends provides cash flow for many people. Many investors (of all kinds) consider speculative investing as a losing proposition (and I will not get into the pros and cons of the nuisances of everything) but I will say that different investment mediums will work for people if they know how to work their strategies.

As I stated, my reasons for getting into Forex is because of the hours (I am EST) but time frame may still be a challenge.

#10

Toekan,

After studying how risk is determined with a person’s profit loss by determining percentage of Total Capital, and since I am going to start with a $2,000 account on FXCM, if we are going to determine our leverage, what is the ideal leverage ration to start with? You said you can trade on 20:1 on a 1000:1 account but not vice versa (I am going from memory) so you seem to be suggesting to start at 50:1 leverage with an initial account balance of $2,000 but I can trade with leverage of 20:1. Is that what you are saying?

Thanks for your help.

#11

100:1 is like trading options. So if you have experience with that 50:1 may even appear slow to you. Some consider 20:1 already as high. It actually depends on your own style. If you trade like Warren Buffet (High timeframe) you probably should work with a lower leverage. The higher the leverage the less room your trade has to manoeuvre. I recently worked out an example in another thread: 301 Moved Permanently.

So I should know a little bit more about you to determine. But if your question is, do you advice 20:1 instead of 100:1 or higher -> yes I would advice to go for 50:1 or 20:1. But if you want to trade like Warren Buffet you might even want to go for 1:1 or lower. :smiley:

For example: Let us say that you are a long term trader and you place one trade a year. For this example you opened a trade on January 4, 2015. It is a long trade and you don’ t want to risk more than 20% of your equity. Looking back now that means that you should have placed a 0,02 lot trade which was [U]1:1[/U]. It is actually 0,0027 lots (about 1475 pip) but that is not allowed. Your trade would have experienced a 15% drawdown

Now you place a long trade every month, again a max loss of 20%: 0,04 Lots (958 pip drawdown jan 2015) -> [U]2:1[/U]
Weekly: 0,08 Lots -> [U]4:1[/U]

So the smaller your timeframe the more likely you can trade with a higher leverage, depending on your risk appetite and your aim to maximize returns. If you trade on the M5 or the M1 chart and you manage your trades (keep an eye on it) you may consider to trade 50:1. I hope this explains a bit why it is important to know what your style is to determine an advisable leverage.

#12

You gave the answer yourself. Deposit $2000 2% risk is $40. loosing 50 trades in a row will blow up your account 2000/40 = 50
With 50:1 leverage and taking 2% of $100000 = $2000 It takes only 1 loosing trade to blow up your account ( $2000 in Account - $2000 loss ) x (leverage 50) = 0

#13

Something that confuses new forex traders is the fact that people use the generic term “leverage” to refer both to “effective leverage” and “maximum leverage”.

This earlier discussion can help you to understand the difference: 301 Moved Permanently

If you live in the US, then CFTC regulations allow you a maximum leverage of 50:1. If you want to trade with an effective leverage of 20:1 with $2000 in your account, then you can control up to 40k (20 times $2000) in total open positions at any given time.

With 40k, you are risking $4 per pip. In another discussion, you mentioned, that you want to risk a maximum of $40 per trade. That means with a 40k position, you can only risk 10 pips. That limits you to extremely short term trades. Instead, you might want to consider placing smaller trades. For example, with 2k positions, you could risk 20 cents per pip, allowing you to risk up to 200 pips.