How To Calculate Risk In Forex

by Hugh Kimura on January 23, 2012 · 12 comments · Trade Well


I occasionally drop in on a couple of the Forex forums out there to find out where beginning Forex traders need help and I try to answer questions when I can give a good response.  One of the questions that comes up often has to do with calculating risk.

There is a lot of confusion out there amongst beginners not only about risk, but how leverage and interest factor into the calculation.

Needless to say, these forum posts end up being super long threads about how to calculate your leverage, then how to calculate your risk and some people even throw in an interest rollover calculation into the mix just to show you how smart they are.

Quite frankly, it isn’t that complicated.  I feel bad for the beginners who have to read through these long, drawn out forum posts when the solution is very simple.  If you are just getting started in Forex, here is how to calculate risk in Forex.

Easy, right?  I’m all about making things as simple as possible.

I’m using Oanda as an example because they are my broker, I do not get paid to promote them.  Check to see if your broker has a similar risk calculation on the order screen.  If not, you may consider switching to a broker that does.

The great thing is that you can try out demo accounts from almost all of the brokers out there and see how you like their platform.  So before you switch or even before you deposit real money, start demo trading and figure out which broker works best for you.

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About The Author: Hugh Kimura
Hi, I'm Hugh Kimura and my mission is provide you with the very best information about trading and living better through research and my own personal experience. You can also follow me on Twitter and Google+. Note: All information is for entertainment and education only and is not investment or trading advice.


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What Do You Think?

TradeThief January 24, 2012 at 11:20 pm

Hi, just found your site a few hours ago, and I just wanted to say hi and good luck with trading, I’m trying to become a professional too.

Reply

Hugh January 27, 2012 at 4:21 pm

Thanks! Good luck to you too! How is it going for you?

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Jay February 8, 2012 at 7:04 pm

What is the bestway to trade forex to make money? Does people make money from this trade? I started but always loss. My platform is ufxmarkets

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Hugh February 8, 2012 at 10:02 pm

The best way to trade is to find a strategy that suits your personality. You need to do a lot of testing and practice. It is NOT a get rich deal or magical formula that will make you successful. Check out my pro trader interviews to learn about people who make money trading.

Good Luck!

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Jay February 9, 2012 at 2:50 pm

What are the strategies to trade. Where do I find it.

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Hugh February 9, 2012 at 5:15 pm

You have to look around and try different things. I would recommend Chris Lori, Hector Trader, Rob Booker and Rudy Leder. They are all a good place to start your education.

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Andrew August 23, 2012 at 4:58 pm

Hi Hugh,

For those not using Oanda, can you recommend a calculator that’s similar but available online?

Reply

Hugh August 24, 2012 at 2:16 pm

Hi Andrew,

Sorry, I don’t know of anything at the moment. The cost per pip can vary between brokers, so you would really need to get something that is broker specific. If I find anything, I’ll let you know.

Hugh

Reply

Shawn Michaels October 22, 2012 at 6:43 pm

Hi Hugh !

Thanks for the great website and free resources. First things first, you have awesome communication skills and voice to suit that as well. Very plain and simple way to explain things. :) Here is my question for you:

I am a bit confused regarding using these calculators. If I have $2,000 account size, my risk% per trade is 1%, and my stop-loss is 30 pips, this boils down to 6,667 units (lets assume EUR/USD at 1.3000). This part I understand very clearly.

Now if I have leverage of 400, how the leverage will come into play ? Because if my leverage is 400 and my account size is 2000, then I can buy 800,000 worth of a pair (depending on the price). I am confused because I think its kind of circular cell reference thing.

Another way of saying this is, for example, given the above calculations, if I am buying 6667 units and hit my stop loss, I will only lose $20. But now lets say we want our leverage and margin to determine the position size and then stop loss (lets say we want to buy 10000 units and 30 pips stop loss). How would we do that?
Can you please explain that?

Looking forward to hearing from you.

Thanks again.

:)

Reply

Hugh October 23, 2012 at 7:34 pm

Hi Shawn!

Appreciate the kind words about me and my blog.

Good question. Let me start by saying that things could be different between brokers (like value per pip, max leverage, etc.), so check the specifics with your broker first.

Leverage (in forex) primarily refers to the ability to use a certain amount of cash (or margin) to borrow a larger amount of money. So if your leverage is 400:1, then you are putting up $1 to control $400 worth of currency. The margin that you are putting up is held by the broker for the duration of the trade and cannot be used to take any other positions. It is returned when you close the trade.

Think of it like buying a house. You put down $20,000 in cash, but control an asset that is worth $100,000 (5:1 leverage). So now you are subject to the fluctuations of the $100,000 asset, instead of only what could happen with your $20,000.

Here is my suggestion…do not worry too much about the leverage when it comes to position size. If you understand that you are only risking 1% or less per trade, then that is the key. Leverage only comes really into play when you are trading several positions. You need to have enough margin in your account to take all those trades.

People get into trouble with higher margin because they say, “Oooo, I still have $1,900 in available margin, what else can I trade?” Or they risk like 75% of their account per trade, just because they can. If you stick to your trading plan and only risk 1% or less, then even if your system sucks, you will lose money much slower than people who are trying to hit homeruns with high leverage.

One time when it may come into play more is if you are trading a currency pair that has a high interest rate differential (like AUDJPY). Higher leverage means that you are borrowing more money per $1 in your account and that means you will pay (or make) more interest.

So just do as you have been doing, calculating the number of lots/units, given the price per pip and the $ amount of your max 1% loss per trade.

Hope that simplified it.

Cheers,
Hugh

Reply

Shawn Michaels October 22, 2012 at 6:50 pm

Hi Hugh !

Here is what relates to my question above (I read it on another website):

“In forex, the calculation of risk is first determined by the leverage, and then by the stoploss. Suppose we use a broker with a leverage of 1:100, and our stoploss is 100 pips. So if we have $10000, we should open a trade with 0.2 lots. If we win a little bit, we try 0.21. If we lose a little, we try 0.19. The lotsize is always 2% of our account free margin. In this way, we always keep a balance between risk and growth.”

Now you see at the end, he says: “The lotsize is always 2% of our account free margin”. I think that’s what is confusing me. Can you please explain that by a little example so that out position size (lot size) is 2% of our account margin or usable margin (whatever it is)?

That would be so kind of you.

Thanks for your kind help Hugh.

May God give you the desire of your heart and succeed all your plans.

Happy Trading ! ;)

Reply

Hugh October 23, 2012 at 7:35 pm

Thanks for the warm wishes, I think my previous response should clear things up.

Reply

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