On this page you’ll learn how much to risk on each trade and how to work out a trade’s size based on your stop. You’ll also see how quickly losses become hard to win back and how trades that look separate can add up to one big bet. After that come the types of stop, what a sudden price jump does to each of them and the habits that turn a manageable loss into a total one.
Key points
- Risk per trade is the amount you lose if your stop is hit. You decide it beforehand as a fraction of your account, and your trade size comes from that figure and from how far away your stop sits.
- Trade size is the risk amount divided by the stop distance times the value of each point the price moves. Your provider also asks for margin, the deposit it holds while the trade is open, but that figure plays no part in the calculation.
- If you lose half your account, you have to double what’s left just to get back to where you started. Losing seventy per cent means you have to more than triple it. That’s plain arithmetic.
- Trades that seem separate are often one bet. When trades move in the same direction, their impact combines across your full account. That’s when the close-out rule of the company that opens your account kicks in, shutting down your trades if your account falls too low.
- A limited loss becomes an unlimited one through three habits: averaging down, revenge trading and moving your stops.
Risk per trade
Risk per trade is what you lose if a trade hits its stop-loss, the price you’ve chosen to exit at. You decide this amount as a fraction of your account before opening the trade, and it’s a rule that doesn’t depend on any forecast. It determines how many losses in a row your account can endure before it becomes too small to recover, and the drawdown recovery table shows what “too small” means.
Every strategy listed on the trading strategies page goes through losing streaks of ten or fifteen trades from time to time. A sensible fraction lets your account live through a run like that, but a fraction that only survives three losses in a row isn’t risk management at all. That kind of fraction is a countdown.
Risk per trade isn’t connected to the margin your provider asks for. Margin is the deposit your provider needs before you can open a trade. Risk is the amount you lose if the stop is hit. On a leveraged product, one can be many times bigger than the other and it can go either way.
Position sizing from the stop distance
Illustrative figures: a made-up example, not a forecast or a quote.
Position sizing from the stop distance works out how many units to trade from your risk-per-trade rule, and it takes four steps. The numbers that follow are made up. Imagine your account holds 5,000 and you risk 1 % per trade. The currency pair you trade gives each pip, the smallest usual step in its price, a value of 1 for every 10,000 units.
- Fix the risk amount 1 % of 5,000 is 50. If the stop is hit, you lose 50.
- Set the stop from the chart, not from the money Place the stop at the point where your trade idea is proved wrong. That might be below a support level or beyond the recent range, at a distance the market’s normal ups and downs are less likely to reach. Suppose that distance is 40 pips. Everyday noise can still hit a 40-pip stop, because a major pair can easily cover 50 to 100 pips in an ordinary day.
- Divide Trade size = 50 ÷ (40 pips × 0.10 per pip per 1,000 units) = 12,500 units. That’s about 1.25 mini lots, where a mini lot is 10,000 units. A wider stop of 80 pips gives 6,250 units, and a tighter stop of 20 pips gives 25,000. The stop distance sets the size, never the other way round.
- Check the margin and the effective leverage At a price of 1.1000, 12,500 units make a trade worth 13,750, and that figure is its notional value, the full size of the trade. This notional value of 13,750 needs 458 in margin at a margin rate of 3.33 %, against 5,000 in your account. Your effective leverage is 2.75:1, calculated as the trade’s full value divided by your account. Margin was never the limit here. Your risk rule was (leverage and margin).
The same four steps work for an index CFD and a share CFD. You use the value per point or per share instead of the pip value. On every market, the trade size is the answer the sum gives you, never the number you start from. You’ll find the formulas for pip value, lot size and position size on the pips and lots page.
The drawdown recovery table
Worked arithmetic: the numbers follow from the formula given in this section.
After a loss, the drawdown recovery table tells you how much gain you need to return to your starting balance. A drawdown is the fall in your account from its high point to a later low. The gain you need grows faster than the loss. That’s because you’re making it on a smaller balance. The formula is: gain needed = loss ÷ (1 − loss).
| Loss | Balance left (from 100) | Gain needed to recover |
|---|---|---|
| 10 % | 90 | 11.1 % |
| 20 % | 80 | 25 % |
| 30 % | 70 | 42.9 % |
| 50 % | 50 | 100 % |
| 70 % | 30 | 233.3 % |
You can win back a 10 % loss in one ordinary good month. A 50 % loss means you have to double the account, and for most strategies that takes years, if it happens at all. A 70 % loss nearly always ends the account. Setting your risk per trade low keeps you in the top rows of the table, where getting back is a matter of plain arithmetic and needs no heroics.
Correlation and account-level exposure
The risk-per-trade rule overlooks correlation and account-level exposure when applied to each trade individually. Correlation means two prices tend to move together. Three trades, each risking a small slice of your account, add up to a big risk if they move together, and in a CFD account they usually do.
Say you’ve bought two stock indices, an oil contract and a currency whose value follows raw-material prices. Together they make one bet that investors stay in the mood for risk. A sell-off can hit all four stops in the same hour. So you need a second limit, on the total risk across open trades that are likely to move together. A third limit caps your effective leverage. That’s the total value of your open trades divided by your equity, meaning your balance plus any profit or loss on open trades (leverage and margin).
If the company that opens your account is regulated in the EU or the UK, it applies the close-out rule to your whole account too. It closes trades when your equity falls to 50 % of the total margin needed, whichever trades caused the fall (ESMA ESMA Decision (EU) 2018/796). A global company closes trades at whatever level its own terms set. One bad move can take an account full of trades that move together to that point. That’s how an account that seems to hold many separate bets gets emptied in a day (forex trading).
Stop types and gap risk
Different stop types guard against different things, but none shields you from gap risk. A gap is a price jump with no trading in between, which can happen over a weekend or after company results.
- Ordinary stop-loss
- Closes your trade at the next available price once the price reaches your level. It limits the loss in a calm market, but in a gap it fills beyond your level. So your planned loss at the stop is the least you’ll lose, and the real loss can be bigger (how a trade works).
- Trailing stop
- Follows the price at a set distance as it moves your way, and locks in gains while the trend lasts. Set it too tight and ordinary price wobbles trigger it. Set it too wide and it gives back most of the move (trailing stops).
- Time stop
- Closes your trade after a set time if the move you expected hasn’t happened. The thinking is that a trade that hasn’t worked is costing you overnight financing, the daily charge for holding a trade open, for nothing. It’s a rule you keep yourself, and platforms don’t offer it as an order type.
- Mental stop
- A mental stop is a price you intend to exit at without placing an order. It fails in exactly the moments it’s meant for, because you have to act just when you least want to. A mental stop is the most common way people end up moving a stop.
Gap risk is why the stop level and the loss at the stop can be different numbers on a CFD. Gaps tend to happen at the market open, over the weekend and around company results, as the indices trading and shares and crypto CFDs pages show. The stop-loss orders page explains why a stop can fill at a worse price than its level.
The habits that turn small losses into big ones
Three habits turn a limited loss into an unlimited one in leveraged trading, and each one seems sensible when you’re doing it.
Averaging down
Averaging down is when you add to a trade that is already losing. Your average entry price gets better, so a smaller bounce brings you back to break-even. But you double your stake in a trade the market has already moved against. So a planned risk of one per cent turns into an unplanned two per cent, and then four. On a leveraged account, the most direct route to the close-out level is averaging down.
Revenge trading
Revenge trading is opening a new trade right after a loss to recover what you lost. The new trade is usually bigger than the one before. Revenge trading replaces a rule with an emotion. You choose the trade size to match the loss you just had, and you pick the entry because you want your starting balance back. No market analysis plays a part. The usual way to stop it is a rule that ends your trading day after a set loss. That rule only works if you write it down before the loss happens.
Moving stops
Moving stops is the act of shifting your stop further out when the price nears it. Because you worked out the size for the original stop distance, this undoes the position-sizing arithmetic completely. Moving a stop from 40 pips to 80 pips doubles your risk on the trade with no change in size. A stop you keep moving is no stop at all. On a leveraged account, your only stop then becomes your provider’s close-out, at whatever level its company sets (leverage and margin).
Questions about risk management in trading
Questions about risk management mostly cover what it means, how you size a trade and what a stop can and can’t do.
What is risk management in trading?
Risk management in trading is a set of rules that limit how much one trade can cost you and how much one bad week can cost you. The main rules fix how much loss you take per trade, how much total risk you carry across open trades and when you stop for the day. None of them needs a forecast.
How do you calculate position size?
Position size equals the amount you’re willing to lose divided by the stop distance times the value of each point. You fix the risk amount first and set the stop from the chart, and the size follows. The steps above walk through one example, and the pips and lots page has the formulas.
Does a stop-loss limit your loss?
In a calm market, a stop-loss limits what you can lose. But when the price jumps, the fill can happen beyond your stop level. So if your stop is hit, the loss at that point is the smallest you’ll face (stop types).
What is a drawdown in trading?
A drawdown is the drop in your account from its peak to a lower point later on. The gain needed to get back to even rises more quickly than the loss, since you earn it on a reduced balance. The recovery table shows how this works.
What is a stop out level?
A stop out level is the point where your provider starts closing your trades because the account has run too low. EU and UK rules call it the margin close-out level. At a company regulated in the EU or the UK, it comes when your equity falls to 50 % of the margin your open trades need (ESMA Decision (EU) 2018/796, leverage and margin). A global company sets its own level in its terms.
Risk warning
Risk management limits your losses but can’t give you an edge
Risk management limits the size of your losses but can’t give you an edge. An edge is a real reason to expect a profit over many trades. Careful sizing with a strategy that has negative expectancy and loses money on average per trade only makes you lose more slowly. Careful and careless traders alike appear in the regulators’ loss figures. In 2018 ESMA reported national regulators’ findings that between 74 % and 89 % of retail accounts lost money (ESMA press release, 27 March 2018). The demo accounts page shows how to find out what your strategy does before real money is at stake.
Sources
The original documents this page cites, in the order they first appear.
- European Securities and Markets Authority, ESMA
- ESMA Decision (EU) 2018/796 of 22 May 2018 to temporarily restrict contracts for differences in the Union, Official Journal of the European Union (EUR-Lex), 2018-05-22
- ESMA agrees to prohibit binary options and restrict CFDs to protect retail investors, ESMA, 2018-03-27