On another thread (on the Rate My Broker forum) Dale Paterson included this comment in one of his posts:
I have to disagree with my good friend from Johannesburg.
[B]I think the 2% risk rule is appropriate for very small accounts, just as it is for larger accounts. [/B]
Basically, the 2% risk rule says: on each trade, determine your risk exposure in pips, and set your position size such that the dollar-value of your exposure is not more than 2% of your account balance. If you just love to do math all day, then you can run these calculations prior to each trade you enter. But, there’s a much easier way.
[B]The Lazy Man’s Way to Determine Position Size[/B]
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Determine your maximum stop-loss setting. In my case, that number is 50 pips. The way I trade, a 50-pip stop-loss (or less) is totally sufficient, and I’m just not comfortable setting a stop-loss further away than that.
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Calculate the maximum leverage you can use, such that a maximum loss in pips will produce a 2% loss in your account.
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[B]Use that same leverage on every trade[/B], whether you are using your maximum stop-loss, or not.
In my case, my personal maximum 50-pip stop-loss corresponds to 4:1 leverage. And this is the leverage I use on every trade.
Let’s check the numbers, to prove that 4:1 leverage and a 50-pip stop-loss will limit risk to 2% of account balance, regardless of what the account balance is.
Example 1. You have a $500 account. 4:1 leverage means each trade is 2,000 units of currency, which equals 2 micro-lots. This is your maximum position size on every trade. If you are stopped out, your loss will be 50 pips, which equals $5 per micro-lot, or $10 for your 2-micro-lot position. $10 is 2% of your $500 account balance.
Example 2. $1,000 account. 4:1 leverage. 4,000 units of currency = 4 micro-lots.
Stop-loss: 50 pips = $5 per micro-lot = $20 total loss = 2% of account balance.
Example 3. $3,500 account. 4:1 leverage. 14,000 units of currency = 14 micro-lots.
Stop-loss: 50 pips = $5 per micro-lot = $70 total loss = 2% of account balance.
Example 4. $20,000 account. 4:1 leverage. 80,000 units of currency = 8 mini-lots.
Stop-loss: 50 pips = $50 per mini-lot = $400 total loss = 2% of account balance.
Example 5. $100,000 account. 4:1 leverage. 400,000 units of currency = 4 standard lots.
Stop-loss: 50 pips = $500 per standard lot = $2,000 total loss = 2% of account balance.
If you’re not comfortable with a 50-pip maximum stop-loss, and prefer some other limit to your exposure, then calculate the leverage which corresponds to the stop-loss you’re comfortable with. Similarly, if you’re not comfortable with a 2% risk to your account balance on each trade, then calculate the leverage which corresponds to your risk tolerance.
Once you have set a limit on your risk per trade, you can use the same leverage limit on every trade, without a lot of number-crunching. If your broker defines position size in term of lots (nano-, micro-, mini- or standard), then as your account balance takes on various values, you will have to round down to a whole number of lots, when you are establishing position size. But, you can do this in your head.
Most new traders, with tiny accounts and dreams of big profits, grossly over-leverage their accounts, risking far more than 2% of their account balance on each trade. This is a formula for disaster.
2% is a prudent MAXIMUM risk figure, in my opinion. For some traders, less is even better.