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Trading: Risk Little, Risk the Lot

Posted in Forex Trading | Traders' Delusions, Submitted by Trading Critic on Wed, 2006-09-06 13:41.
Forex trading: do you risk the lot or risk a little when you trade the foreign exchange markets

Traders are risk takers. We accept the market risks in the hope of making a killing making a living from trading the markets. Here I will discuss a case study on the consequences of leverage and the critical decision whether to "risk little or to risk the lot." I will use the forex markets for this case study. Similar concepts apply across other markets, but this particular concept works well with the foreign exchange markets due to their volatility. You may not agree with me with this case study and I reserve the right to change my position on this at anytime. Also, this is written for people with some experience in trading forex.

After trading the forex markets for a few years and a little reflection I came up with this thought: I can risk a little or risk a lot. You've got two choices and four outcomes. First you have the choice of either risking a little money or risking the lot. The secondary outcome for both cases is not your choice: it is up to the market to decide whether it shall go up or down.

Yes, so aren't you stating the obvious? What's the point? The point is, your initial choice of the amount of leverage is critical in determining your success in trading the forex market. But Marco? How did you arrive to that conclusion? Bear with me and you'll see. In this case study we will use the AUD/USD (Australian and US Dollar) currency pair, assume we are trading a standard contract size where each contract is worth $100,000 and so 1 pip equates to US$10. So in this case we will assume that we have a profit target of US$1000 for this particular trade. How we make that amount of profit, and the amount of risk you take on board depends on your fundamental choice (of risking a little or a lot) as well as the volatility of the particular equity. For the Aussie and US currency pair, it is quite rare to see 100 pip movements per day, unlike currency pairs such as EUR/USD (Euro/US Dollar). Typically the Aussie moves around 20 to 50 pips a day. That is the amount of volatility we are playing with. So to be realistic about your profit , assuming you are day trading and perfect "market conditions" (the market is going the way you set your trade), you should only expect to make 20 to 40 pips a day (that is in optimal circumstances - remember this is only a case study after all).

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