Monday, March 2, 2009

Never risk more than 2%" on any forex trade

It's an advice you will hear from many professional traders. Trust me, they know what they are talking about. Why is it so important to follow this rule? Successful forex traders have high winning ratios(70% or more), so why don't they risk more? Maybe 5%!

Let's examine the roulette game. There's a 50/50 chance for either black or red. So you may think that out of 10 events you could expect 5 red and 5 black. You couldn't be wronger. I've personally seen 24 red numbers in a row. I couldn't believe my eyes but the casino employees weren't surprised at all and when i talked to one of them he told me he saw streaks like this many times and that he remembers a streak that went over 35. So my point is that even with a high winning ratio system you can still experience a large drawdown on your account if you don't respect the "2% rule".

Loosing streaks happen to successful forex traders too, you can't avoid that, the difference between you and them is that they don't get emotional when this happens because they never risk more than 2%. Not getting emotional helps them steak to their trading rules and survive the loosing streak.

I guarantee you that if you follow this rule you will improove your trading results. Not risking your shirt on a trade keeps you cool and concentrated on the market making the right decisions.

PS1: Don't lie to yourself by bending the rule thinking you could trade multiple pairs at the same time. If you are in a long EUR/USD trade risking 2% that's it. You can't buy GBP/USD and pretend it's another trade. EUR/USD and GBP/USD have a 95% correlation ratio so it's like risking 4% on EUR/USD.

PS2: Never ever violate this rule even if you are 100% certain that you have a great trade that you couldn't possible loose in a million years. As John Maynard Keynes used to say: "the market can stay irrational far longer that you can remain solvent” Forex traders are not gamblers so don't put all your eggs in one basket!

Happy pipping!