We most often hear about how emotional a trader becomes when his losses keep multiplying or when he struggles to break-even. Naturally, the trader would be left with two possible options: to top up or to give up. This disheartening or confusing situation usually digresses into a downward spiral of other unwanted feelings. It would then influence the trader who's in desperateness to believe that he needs to get back at the market so he could recoup his losses.
More about managing your Mental State or having the right mode of Beliefs as well as the Mental Strategy are covered in greater length in the 'Trading Psychology' section.
LEARN MORE ABOUT TRADING PSYCHOLOGYSo, as we initially mentioned about 'getting back at the market', how does a trader revenge trade? Well, it's almost too easy from being in a least resourceful state driven by false beliefs, to actually fall into the trap of 'overtrading'. Simply by making the mistake of not managing his Lot Sizes, the trader loses control over his fast diminishing equity, almost to the point of no return.
Before going further, it's essential to first understand what Money and Risks Management entails as they do slightly differ from one to another. However, to manage your money will enable you to manage your risks as one compliments the other and their differences are explained below:
To properly manage your Money, you would need a 'System' or 'Formula' that will enable you to decide your Lot Sizes. In other words, it's about how many Lots to trade for every single trade you are thinking of executing. Having a system in place, will then allow you to take the 'Emotions' out of trading as well as reduce risky intentions in using 'instincts' or 'gut feelings' to make financial decisions.
How big a Lot Size you are supposed to open per time of trading?
Managing one's Risks is directly related to an individual's 'Risks Tolerance'. In order to manage your Risks better, you would need to be aware of the impact your trades will have towards your remaining equity of the account as a trader before either getting a Margin Call or being Stopped out. Therefore, in Risk managing of any trade could be measured based on the percentage of your account you are willing to risk, if the trade goes against you.
How disciplined are you, in not breaking the 'Percentage of Equity to be risked' rule?
Respective of the subject of Money & Risks management, traders are habitually confused about where they should start from or what exactly they need to know and apply into their trading.
With that, we came up with crucial pointers as Tips whilst ranking them in level of importance from #1 to #5.
| Question: | How big a Lot Size you are supposed to open per time of trading? |
| Answer: | You need to firstly decide on two crucial areas as follows: |
Lets assume you are starting with an equity balance of $10,000. Based on the above you are willing to risk 3% of it. This will be $300. Based on your strategy, by determining Support & Resistance or through indicators you have decided, let's say you decided on a Stop Level of 100 pips which is the amount you personally wish to Risk.
What you can do is then to include the answers to the above into the simple formula below:
| IDEAL LOT SIZE TO TRADE | = RISK IN DOLLAR AMOUNT / RISKS IN PIPS |
| = $300 / 100 PIPS | |
| = $3 PER PIP (MAXIMUM FOR THAT SPECIFIC TRADE) / RISKS IN PIPS |
This would mean you are going to be typing in the option of 0.30 once you click on 'New Order' and under the 'Volume' section which is equal to 30,000 units. See example below specifically for the EUR/USD pair:
However, please be aware that value per pip may vary in accordance to the base currency of your account and the chosen Instrument as shown in the table below:
| INSTRUMENT | BASE CURRENCY | TRADE SIZE (Units for currencies, Oz for gold) |
PIP VALUE |
|---|---|---|---|
| EUR/USD | EUR | 30,000 | 2.82 EUR |
| USD/JPY | USD | 30,000 | 2.66 USD |
| AUD/USD | AUD | 30,000 | 3.91 AUD |
| GBP/JPY | GBP | 30,000 | 2.12 GBP |
| CHF/SGD | CHF | 30,000 | 2.12 CHF |
| XAU/USD(Gold) | USD | 1 Lot (100 Oz) | 1.00 USD |
***Note: The % of amount you are wanting to Risk from your Equity is a personal decision that Traders needs to be accountable for.
Margin Requirement is necessary for you to determine what your Margin Call and Stop Out levels are.
When a Trader opens an account with a broker for example, an initial deposit is required in order to open a position in the market. The required cash deposit will act as a capital to cover any credit risk. Depending on the Terms and Conditions of the agreement, the investor could be able to leverage up to a certain limit.
Margin Requirements could also be considered as the leverage offered by a broker. A 2% Margin requirement is equivalent to a 50:1 leverage while a 1% margin requirement could be referred as a 100:1 Leverage.
Margin = 1/Leverage
To understand the Margin using the simple formula mentioned above, see the example below:
Let us say that on default the Leverage offered at the broker is 1:50 then the Margin
| would be | = 1/50 |
| = 0.02 × 100 | |
| = 2% |
Margin Requirement: Units Traded × Current Price × Margin
To understand the Margin using the simple formula mentioned above, see the example below:
You want to buy 100,000 Euros (EUR) with a current price of 1.070 USD, and your broker requires a 2% margin.
| Required Margin | = 100,000 × 1.070 × 0.02 |
| = $2,140 |
Based on the example above, you will be needing a balance of a minimum of $2,140 to be able to sustain the trade you wish to execute. You will then be able to convert the based on current exchange rates into Euro.
***Note: Please refer to the 'Pip Value Table' depending on the base currency or chosen instrument.
Margin required depends on which currency your Trading Account is denominated in. For example:
Account Equity = Required Margin × 80% (to get a Margin Call)
Account Equity = Required Margin × 50% (to be Stopped Out)
Traders are usually alerted when their Equity is equal to 80% of the Required Margin, they will get an alert from their broker, it will simply be a red highlight on the their MT4 Trading Platform.
A Margin Call is telling you that your equity is insufficient to keep the active trades opened or to continue trading. To keep active positions opened means that a trader may have to either close some of the trades or Deposit more funds to their trading account to meet the minimum Margin Requirements.
At a broker for example, the Margin Call = 80%. Firstly, you would need to know the Margin Requirement to find out your 'Account Equity' that would alert you the Margin Call as per the formula below:
Following the example as shown in TIP #2, the Margin Requirement needed for trading the EUR/USD was $2,192 so you would need to insert the details into the formula above as follows:
| Account Equity | = $2,192 × 80% |
| = $1,753.6 |
***Note: This means that once your Equity has been reduced to the amount of $1,753, your Broker's Trading Platform will be highlighted, alerting you of a Margin Call.
Traders are usually Stopped Out when their Equity is equal to 50% of the Required Margin of which your Account will trigger Stop Out.
A Stop out Level is neither an alert nor a warning anymore as once the trader ignores the Margin Call and fails to re-capitalize or fund his account, the System will perform an automated closure of all your trades as mentioned above.
Following the example as shown in TIP #2, the Margin Requirement needed for trading the EUR/USD was $2,192 so you would need to insert the details into the formula below, as follows:
| Account Equity | = Required Margin X 50% (Gets Stopped Out) |
| = $2,192 X 50% | |
| = $1,096 |
***Note: This means that once your original Equity has been reduced to the amount of $ 1,096, you would most will be Stopped Out.
A drawdown is simply a drop in your account size or equity and usually presented as a percentage of the account.
A drawdown can be stated in one of two ways:
1. To consider the losses in absolute terms, such as money or pips.
2. To consider it in terms of percentage.
The percentages will help a trader with the analysis in the capacity of the specific trading strategy, while the absolute values of money or pips, will help primarily in the construction of his 'trading portfolio'. Whichever approach that's chosen, in any event, would coincide in supporting the decisions on Risks and Money management.
Percentages as illustrated in the table below, help us to observe the drawdown from another interesting perspective. If a Trader loses 50% of his equity, to return to the level of break even, it will NOT be a new performance of just that 50% that he has lost, but rather it’s 100%. The reason being, if he had lost 50% of his equity, he has halved his gains, therefore he has lower amount of capital or has halved his capital. To make sure that half will come back to being a whole, he needs to double it, in other terms, to create a performance of a 100%. We must therefore always be careful, because the higher the drawdown, the more the struggle will be to recover the profits.
| LOSS OF CAPITAL (DRAWDOWN) | REQUIRED RETURN TO REPAIR DRAWDOWN |
|---|---|
| 10% | 11.1% |
| 20% | 25% |
| 30% | 42.9% |
| 40% | 66.7% |
| 50% | 100% |
| 60% | 150% |
| 70% | 233% |
| 80% | 400% |
| 90% | 900% |
| 100% | Oooops! |
