Lesson #1 – Understand the basics of trading is understanding how much you will lose.
After the 2 first article dedicated to the global sense of trading: ” is simple ” and the choice of your first “strange partner” (the broker), we will speak about losing.
Indeed Trading is a matter of what you will lose. To stay in the game, you need to control this aspect. How much you will lose when you will lose because you will.
For that, you need to understand some basics figures and computations you will need to know to see where is your risk.
Indeed you will choose the amount of money you will play – the lot size – thanks to the risk level you will take.
Starting from the beginning, a “rate” is usually composed by a figure, a comma and 1,2,3,4,5 digits…
Like for EUR/USD for example, 1.2326 now in some brokers with 4 digits, 1.23261 in the other broker with 5 digits.
I won’t do an academic lesson about the theory of money because we don’t care – totally –
And no explanation too about what is “to buy EUR/USD” and what is “to sell EUR/USD” with some emphasis on what currency you sell ect. I let you see the very good website about the subject if you have a passion about “the why”.
But let me explain to you that “the why” is out of the scope. You don’t care. As this lone wolf, you need to be, why this little sheep is too slow is not a problem. Your only problem is to chase him and eat him. Don’t think too much. Take care of your brain and thinking too much is not a good way to be “on alert”.
Ok…going back to the price of EUR/USD it’s 1.23213 for example.
You have a BID : 1.23210
and a ASK: 1.23213
Between the 2, you have the spread – here 0.00003 which is the commission taken by the broker for each order you will place (one time).
Then Rules #1 – more you play, more you are trading, more you are giving money to the broker.
To simplify we begin to count 0.0001 = 1 pip then we have here 0.3 pips of spread which is very low.
Then you will open a position in EUR/USD you will start at -0.3 pips (a negative balance of 0.3 pips).
This pips can be converted to the money of your deposit in your trading account. It ‘s easier to take USD – US DOLLAR – as the deposit money.
What is the value of 1 pip then?
It depends on the amount of money you will engage in the order you will pick: To Buy or to Sell.
When you are selling, you will start with the BID price and when you are buying with the ASK price.
If you buy for 10’000 USD of EUR/USD , the value of the pip is 10’000 x 0.0001 = 1 USD . You can say that you have 1 pip = 1 USD if you play with 10’000 USD
10’000 USD is 1/10 of what we call “a lot”. A full lot of 1.00 is 100’000 USD in the market.
With MetaTrader 4 – the software you can use to play forex-, it’s noted: 0.1 as 0.1 lots (1 lot = 100’000 USD).
How with your deposit of 1000 USD you can play with 10’000 USD in a one single trade ?
In fact, the broker is multiplying the money like Jesus Christ did with bread, It’s the LEVERAGE effect of your money borrowing you x100, x200 x500 or even x1000 the amount of money. This leverage effect is written 1:100, 1:200, 1:500 ect..
This LEVERAGE effect is not free or can even let you gain some money, it’s the SWAP and this SWAP will be computed each day. Note that due to the difference of interest between central bank you can have a NEGATIVE SWAP. It means that the broker is paying you to hold a position – it’s called CARRY TRADING but we won’t speak of that now.
Ok, let’s go back to our(s) sheep(s).
Then let’s imagine you start with an account of 1’000 USD
You want to BUY EUR/USD (we don’t speak about why..)
Ok..
The price (ASK) is 1.23213
What is the “right amount” of money you will use to enter in the market?
You need to refer now of what, for you, is the maximum of loses you can support.
Let’s say 2% for one single trade.
2% for one single trade is 20 USD of your capital
With a lot 0.1 (in Metatrader4), it means that you can afford to lose 20 PIPS
With a lot 1.0 , it means you can afford to lose 2 PIPS
With a lot 0.01 (called mini-lot often), 200 PIPS
Ok…When you enter in the market is not strange to have a quick variation of some pips then 2 PIPS will immediately expose you and you have a great chance to stop and close the position then 1.0 lot is not the right answer. You are doing only “bad gambling” with this lot size.
20 PIPS means that you think that EURUSD can’t be lower than 1.23013 (we did 1.23213 – 0.0020) during the next(s) hour(s), minute(s) ect.
To be honest 20 pips as a beginner is nothing…then you need really to be sure that the trend is BULLISH right now and will stay (means the price are raising).
You are also taking a high risk.
Then 200 PIPS seems to be a more comfortable choice. You could even take 0.02 then afford to lose only 100 PIPS. It stays in the good window of lot size to take with an account of 1’000 USD playing with Forex.
Then what you will play with come from the risk you are willing to take.
Rules # 2: You don’t have to risk more than 2 % of your balance during an operation of trading. Keep this rate in mind and compute your future lot size with it.
Rules # 3: Take a margin to lose between 100 pips and 200 pips in one single operation at maximum to compute the right lot size like we did before
You may have then like a dashboard :
1’000 USD of deposit => 0.01 as Lot size
2’000 USD => 0.02 as lot size
ect..
10’000 USD => 0.10 lot size
Under 1’000 USD you will be over-exposed in any case.
Then 3 rules to start :
Rules #1 – more you play, more you are trading, more you are giving money to the broker. Then don’t play a lot because you are loosing money.
Rules # 2: You don’t have to risk more than 2 % of your balance during an operation of trading. Keep this rate in mind and compute your future lot size with it.
Rules # 3: Take a margin to lose between 100 pips and 200 pips in one single operation at maximum to compute the right lot size like we did before.
