Many of us have read something like "Only risk x percent of your account per trade", as a rule of thumb. However not many of us, specially in Forex have a clear idea on how to achieve this. So, let's get down to business.
Let's say I have a 10 000 USD account and I want to keep my risk per trade to a maximum of 1%, meaning that if I lose a trade, I will lose no more than 100 USD on any single given trade. Now imagine I spot a good trade set up in the EURGBP pair, and I decide to place my stop loss 50 pips away from my entry based on technical details on the chart. The question is how much? how big or small should my position be so that if the price hits my stop loss my trade doesn't cause me a loss larger than 1% or 100 USD in my case?
Well, the key here is to find out how much a pip of EURGBP is worth if I trade one lot. In order to do that there are several websites that offer such calculation, one that I commonly use is http://www.dukascopy.com/plugins/fxMarketWatch/ provided by Dukascopy. Once there, click on the option "Forex Calculator". and then select EURGBP as the currency pair.
As you can see, as of this writing, one pip of movement in EURGBP, playing one lot is worth 16.43 USD. My stop loss I want to set it 50 pips away from my entry (doesn't matter if I am going long or short). So, if my SL is 50 pips away and I trade one lot, I would be losing $16.43 x 50 = $821.50, which is clearly way above the 1% risk, or $100 I was willing to risk. So clearly, playing one full lot here means taking to high a risk.
In order to calculate the exact position size we simply divide the $100 I want to risk by the $821.50 that I risk if I play one lot. And there you go! The result is the correct position size to trade 100/821.50 = 0.12. The actual result is 0.1217 but no broker allows you to play such a position so we've got to round the result.
So, playing EURGBP (either buying or a selling), with the stop loss 50 pips away from my entry, and a position size of 0.12 lots equates to a maximum risk of $100, in this case 1% of my 10 000 account. If my stop loss is hit, I will be losing $100 at most with this position size.
Hope you got that one folks!
Position Size Calculator for Metatrader