How to calculate lot size considering risk and deposit?
Risk management is one of the keys to successful and longtime trading in Forex. Without it is easy to lose all deposits. We want to talk about allowed risk ratio on balance and how to calculate orders lot size. Furthermore, lot size calculator helps us to act fast. Therefore we need to understand how it works.
Especially relevant rule to became good Forex trader – you need to follow safe risk.
The possible risk for one order cannot overcome 3% of deposit. Also, a risk for your trading strategy should be identified and fixed. When all data is known we can apply it to lot size calculator. In case your strategy start work against you, you will be able to save your deposit on time and have time to improve it.
Let say we have the deposit of $100. Allowed order risk is $3 then. Respectively for deposit $1000, it will be $30, and let’s have $7000 example with possible order risk $210.
The ration between take profit and stop loss should be 1/3 and bigger (1/4; 1/5 and so on). In some strategies, 1/2 can be as well, but never use 1/1. More about 1/3 ration rules advantages.
Extremely important to calculate pips price, namely the minimum price change. Pay attention that 1 pip price is not $1 always. It depends on currency pair and could be different given example.
Most of all it will be around $1 price, that’s why we can round to $1 to simplify the explanation. To know the exact price of 1 pip price we offer to use lot size calculator. Furthermore, when we want to calculate USD/EUR pair, we are buying dollars in euros. We need to change dollar pips into euro pips. Due to calculate pip price we use the simple formula: Pip Value = (Pip in decimal places * Trade Size) / Market Price.
Trading 1 lot of EUR/USD with an account denominated in EUR One pip in decimals = 0.0001, Trade Size = 100,000 (1 lot), Exchange Rate = 1.13798 0.0001 * 100,000 = 10 => 10 / 1.13798 = 8.78750 Each pip is worth €8.79.
Considering what has explained above, question what are pips in Forex trading was answered.
Now, then we know all possible risk for order, we can calculate the correct order lot size by using lot size calculator. Let’s have an example then you are holding deposit $1500. The minimum lot size is 0.01, and it cost $0.1. We know that maximum risk for 1 order is 3% of deposit. In our situation it is 1500 x 3% = $45.
Let’s have an example then stop loss for our order is 30 pips.
The lowest (minimum) risk for order with 30 pips stop loss is $0.1 x 30 = $3. Considering that the biggest order risk is $45 it means that we can overcome our minimum risk for 15 times ($45 / $3 = 15). Namely our minimum lot size is 0.01, we can calculate our order volume: 15 x 0.01 = 0.15. It is our suitable lot volume of order when the deposit is $1500 and stop loss is 30 pips.
In conclusion it is: Lot size = maximum order risk ($) / stop loss (pip) / minimum pip price x minimum possible lot.
Finally, I want to add some valuable recommendation in the end. It will help you to determine and control risk more precisely.
1. To avoid increase of risk, we suggest truncating the number to lower. If you calculate the lot size by given formula and result is 0.918 that is 0.9 lot value.
2. You should identify, regarding your strategy, historically, what is the average stop loss size (pip) for each instrument (or pair), to avoid additional unnecessary calculations. Then you will calculate average stop loss for each instrument separately, just add it to given formula, to calculate maximum lot size for order.
3. By the way, you should count spread into the stop loss size, always. If your specific stop loss is 30 pip and spread is 2, the whole stop loss is 32.
4. Do not overcome your risk written in the strategy. Do not risk if you are for sure in 100%, even. Think about long-term perspective, not short term. Follow your identified risks and strategy. Trading is just numbers and statistic. If you break your rules, you will lose.
5. If you do not want to calculate lot size by hand, I suggest you prepare sheet by excel. It will save your time and money for sure.