Forex Strategies and Tips

What Is A Risk Profile?

Some investors talk about "Risk Profile" to describe your general psychology.  Are you a conservative-minded investor?  Are you a thrill seeker?  Are you middle of the road?

But when we talk about Risk Profile, we aren't talking psychology – we're talking money.

RISK:  How much money you might lose on any one trade.

New traders might not even think about that.  They are busy thinking about how much they might make with a trade, not how much they might lose.

But seasoned professionals think first about what they have at risk.  They know that if they handle their risk their profits will take care of themselves.

Using The Same Lot Size For All Trades

When you use the same lot size for all your trades, you let your stop size determine how much you have risked.  Each trade will lose a different amount – a different % of your account – based just on the stop size.

We often meet traders who start by using the same number of lots for all their trades.

They limit their risk by watching how many pips they need for a stop loss.  Here's an example:

    • If they a good setup that needs a 30 pip stop, they'll take it;
    • If their setup needs a 60 pips stop, they may not take it even if it's a great setup;
    • If the setup only needs a 20 pip stop they'll get excited and take it.

Does this make sense?  Is it a smart way to trade?

Well, it's not terrible because they are limiting risk, but it's not great either.

In fact, it's very limiting.

On one side, you cut yourself off from potentially great trades because you think the range is too great.

On the other side, you cut yourself off from MAXIMIZING PROFIT by not using the largest position size you can use when your trade calls for a smaller technical stop.

And it's also limiting in the bigger picture because if your equity is growing you could be using larger and larger position sizes as it does (or should be using smaller and smaller sizes if your equity is in drawdown).

VIDEO: THE PROBLEM WITH USING FIXED LOT SIZES FOR EACH TRADE

Using a Percentage Risk for All Trades

There's another way to take charge of your risk – an approach we think makes a lot more sense... and makes more profit.

Establish a percentage of your account that you are willing to lose on a trade that goes against you, and then use a Position Size Calculator to figure out exactly how many lots you can use.

Let's look at the same example we used above from this perspective.  
(Let's assume an account of $10,000, 2% risk, EURUSD)

    • The setup needs a 30 pip stop; the trader uses 0.67 lots.  If it fails they lose $200;
    • The setup needs a 60 pips stop; they use 0.33 lots.  If it fails they lose $200;
    • The setup needs a 20 pip stop; they use 1.0 lot.  If it fails they lose $200.

When you use a percentage to determine how many lots you place on each trade, each trade will lose the same amount – a fixed % of your account.

Controlling your risk in this way does not limit which trades you decide to take and maximizes profit when trades work well.

VIDEO: THE BENEFITS OF USING A PERCENT OF YOUR ACCOUNT  TO SET RISK  FOR EACH TRADE

Does Risk Change For Different Currency Pairs?

The problem of managing risk – how much you might lose if the trade goes against you – gets more complicated  when you consider that the value of a pip changes with each currency pair you look at.

All but a few currency pair have a variable pip value that changes moment to moment.

Say you put on two trades, both with a 30 pip stop loss.  
One trade is on the EURGBP and one trade is on the USDCAD.  
Both trades stop out.

Which trade ended up costing you more?

VIDEO: UNDERSTANDING THE EFFECT OF DIFFERENT PIP VALUES ON RISK

How Does Loss Effect Your Account

What's the logic behind the numbers in the quiz?  Let's take a concrete example:

Say you start with $1000.  10% of $1000 is $100.

What if you lose 10%?  Now you have $1000 - $100 = $900.

Now let's say you make 10% on your remaining $900.  10% of $900 = $90.

$900 + $90 = $990, not $1000.  You're short by $10.

If you lose 10% you need more than 10% to make it up.

$900 x 11.1% = $99.99, making up the $100 you lost with your 10% initial loss.

The bigger that percent loss, the worse it gets.

(Want to take the quiz again?  Just refresh this web page)

Think Ahead – Where Will You End Up

So the idea here is to think about where you end up if you take a few losses. Think about the long term after-effect of these losses. Part of a solid trading strategy is to plan ahead so you can easily recover from losses and keep trading.

If you dig yourself into a deep hole, it will feel like having to climb up a steep mountain just to get back to where you were.  It's not only difficult to do, but it is also emotionally draining and discouraging.  If you trade this way, you're setting yourself up to fail and probably quit all together before you've mastered trading.

On the other hand, a minor loss can be recovered from in just 1 or 2 good trades.  It's easier to do – both practically and emotionally.

Most professional traders use 2% as their chosen RISK PROFILE.
Mindo Pod, Forex Smart Tools Developer / Professional Trader

If you are trying out a new strategy, you might start by using a Risk Profile of 0.5%, then work it up to 1.5%.

If you have a strategy that you feel fantastic about and have traded with success for some time, you might go up to 3% Risk Profile.  But few professionals will ever use more than a 3% risk, and most stick with 2% for all their trades.

Setting Your Risk Profile in The Advanced Calculator

Because the Advanced Calculator is all about POSITION SIZING, we make setting the Risk Profile very easy.  It is one of the first things you see on the Setup tab.

The little blue question mark to the side also gives you a readout of how much money that risk % corresponds to, so you can see it both ways.

The Advanced Calculator lets you set up multiple accounts with each broker you trade with, as well as demo accounts and Forex Tester simulations.  Each account can be set with its own risk profile %.  Each time you change from one account to the other in the dropdown menu on each tab, that risk profile is automatically carried with it.

This is particularly useful if you have one account you trade more conservatively and another that you trade more aggressively.

When we developed the Forex Smart Tools many years ago, position sizing was only done by professional traders.  We invented the Advanced Calculator so everyone could have the benefit of this powerful advantage.  We put all we could into making position sizing easy, fast and efficient.  Nowadays there are many position size calculators available - What's important is to find one you like that is EASY TO USE... and then use it.

The Forex Smart Tools Calculator lets you set your risk profile for all trades in advance

Don't Forget To Consider Overall Exposure

One last thing to emphasize before we leave the topic of risk...

When you are planning how much you will risk in your trading don't forget to consider all the trades you have on at once.  This is your OVERALL EXPOSURE.

Consider the trader who has seen their ideal setup in their charts on all these currency pair:

  • EURUSD
  • EURJPY
  • EURGBP
  • EURCAD
  • EURCHF

They decide to put on trades on all 5 charts, but they will use their 2% maximum risk profile for each, so they feel they are safe.

Suddenly a big news event is announced without warning that adversely effects the European Union and boom! ~ All their trades are stopped out!

The trader thought using 2% risk kept them safe, but now they are faced with a 10% loss.  This trader made the mistake of trading heavily correlated pairs at once.

If you're in this situation, you can either choose just the best 1 or 2 trades to put on or you could lower your risk profile to go in all these trades. In this example, if the trader had divided their 2% "budget" between the 5 trades, using 0.4% risk for each, then they would have only taken a 2% hit when they all stopped out.

Currency Correlations

If you'd like to see updated currency correlations you may use this chart.  As you roll over each column and row, you'll see the correlations highlighted for you.

The larger the number, the more the 2 pairs you are comparing move in the same way at the same time.  A pair is always 100% correlated with itself, so comparing the EURUSD to the EURUSD will always be 100, etc.

The lower the number, the less each pair has to do with each other.  A score of 0 would mean the two pairs being compared move independently of each other.

Negative numbers show an inverse correlation.  For example there have been times the EURUSD to the USDCHF was -90, meaning they were almost mirror images of each other.  When the EURUSD went up, the USDCHF went down.