Risk management
Manage the loss before you think about the gain.
Risk management is the process of working out and limiting the possible loss before you make a decision. It covers position size, exits, leverage and how several trades add up. This guide walks through each part with the maths shown.
Why risk comes first
Any trading idea can be wrong, and nobody knows in advance which trades will lose. What you can control is how much each trade is allowed to cost, how many trades are open at once and what you do after losses. Those decisions decide whether an account survives the losing runs that every approach goes through.
That is why this guide starts with loss. A strategy without risk rules can wipe out an account even when the strategy itself is reasonable; sound risk rules cannot make a poor strategy profitable, but they keep mistakes small enough to learn from.
Risk per trade
Risk per trade is the amount you would lose if a trade hits its stop loss, usually written as a percentage of the account balance. Fixing it in advance keeps every trade the same "size" in terms of risk, whatever the pair or stop distance.
Many educational resources use 1–2% per trade as a reference point. It is an example, not advice: the right figure depends on your circumstances, and many people use less. What matters is choosing a figure that lets you survive a long losing streak.
| Risk per trade | After 5 losses | After 10 losses | After 20 losses |
|---|---|---|---|
| 0.5% | −2.5% | −4.9% | −9.5% |
| 1.0% | −4.9% | −9.6% | −18.2% |
| 2.0% | −9.6% | −18.3% | −33.2% |
| 3.0% | −14.1% | −26.3% | −45.6% |
| 5.0% | −22.6% | −40.1% | −64.2% |
| 10.0% | −41.0% | −65.1% | −87.8% |
Position sizing, with a worked example
Position size follows from two numbers you decide first: the money at risk and the distance to the stop loss. The size is whatever makes those two match.
lots = money at risk ÷ (stop distance in pips × pip value per lot)
Example. A $10,000 account risking 1% has $100 at risk. The plan is to buy EUR/USD with a stop 25 pips below the entry. With a US dollar account, one pip on one standard lot of EUR/USD is worth $10.
$100 ÷ (25 pips × $10) = 0.40 lots (40,000 units)
Check: 25 pips × $4 per pip = $100 at risk
If the stop were 50 pips instead, the size would halve to 0.20 lots and the risk would stay at $100. For pairs where the US dollar is the first currency, the pip value changes with the price: on USD/JPY at 150.00 it is about $6.67 per lot, so the same $100 and 25-pip stop gives 0.60 lots.
Round sizes down, not up, and remember that spread, commission and slippage can make a real loss slightly larger than the planned figure. The position size calculator and pip calculator do these steps for you.
Stop loss and risk:reward
A stop loss marks the price at which your trade idea is wrong. Put it where the idea is invalidated, for example beyond a recent swing or the edge of a range, and then size the position to it. Avoid picking a stop because of the money, and avoid stops so close that ordinary movement or the spread will trigger them.
A stop is not a guaranteed exit. Over a gap or in a fast market it can fill at a worse price, which is slippage.
The risk:reward ratio compares the stop distance with the target distance. A 25-pip stop and a 50-pip target is 1:2. It tells you how big a win is relative to a loss, but nothing about how likely either one is. Measuring results in R (result divided by the amount risked) makes trades of different sizes comparable: a planned loss is −1R, and a full 1:2 win is +2R.
Try different distances in the risk / reward calculator and see the money involved in the profit / loss calculator.
Break-even win rate
Risk:reward and win rate only make sense together. If every loss is 1R and every win is the same multiple of R, the win rate needed just to break even, before costs, is 1 ÷ (1 + reward).
| Risk : reward | Win rate needed to break even | Wins needed out of 10 |
|---|---|---|
| 1 : 0.5 | 66.7% | more than 6.7 |
| 1 : 1.0 | 50.0% | more than 5.0 |
| 1 : 1.5 | 40.0% | more than 4.0 |
| 1 : 2.0 | 33.3% | more than 3.3 |
| 1 : 2.5 | 28.6% | more than 2.9 |
| 1 : 3.0 | 25.0% | more than 2.5 |
Wider targets need fewer wins but are usually reached less often. Expectancy combines the two: (win rate × average win) − (loss rate × average loss). A high win rate with small wins and large losses can still lose money over time.
Leverage and margin
Leverage lets you control a position larger than the money set aside for it. Margin is that deposit: the position's value divided by the leverage.
0.40 lots EUR/USD at 1.0850 = $43,400 notional
Margin at 1:30 = 43,400 ÷ 30 = $1,446.67
The important point is that leverage changes the margin, not the risk. At 1:30 or 1:100, a 25-pip loss on 0.40 lots is still $100. Higher leverage only makes it easier to open positions that are too large for the account, because less margin is needed.
Margin is not the most you can lose. As losses grow, equity and the margin level fall; at the broker's thresholds you may get a margin call and then a stop-out that closes positions at market prices. Regulators in several regions cap retail leverage, for example at 30:1 on major pairs in the EU and UK and 50:1 in the US, and some require negative balance protection.
Drawdown and recovery maths
A drawdown is a fall from the account's highest value to a later low. Recovering from it takes a bigger percentage gain than the loss, because the gain is earned on a smaller balance.
| Loss from peak | Gain needed to recover |
|---|---|
| −5% | +5.3% |
| −10% | +11.1% |
| −15% | +17.6% |
| −20% | +25.0% |
| −25% | +33.3% |
| −30% | +42.9% |
| −40% | +66.7% |
| −50% | +100.0% |
| −60% | +150.0% |
| −75% | +300.0% |
| −90% | +900.0% |
Losses up to around 20% are uncomfortable but recoverable; beyond 50%, the gain needed becomes very large. Keeping risk per trade small is what keeps drawdowns in the recoverable range.
Correlation and overexposure
Risk per trade only works if you count all your risk. Pairs that share a currency often move together, which is correlation. Buying EUR/USD, GBP/USD and AUD/USD at 1% each is not three separate 1% risks; it is largely one 3% bet against the US dollar.
- Add up the risk of all open trades, and set a maximum for the total, not just for each trade.
- Treat positions that share a currency in the same direction as one larger position.
- Be aware that correlations change, and that in stressed markets many prices can move together.
Emotional and behavioural risks
Many of the largest losses come from decisions made after a loss, not from the original plan. Trading psychology is a risk to manage like any other.
- Revenge trading: jumping into a new, often larger trade to win back a loss.
- Overtrading: trading out of boredom or frustration, paying costs every time.
- Moving the stop further away to avoid taking a loss, which turns a planned loss into an unplanned one.
- Adding to a losing trade, which increases size exactly when the idea is not working.
- Overconfidence after wins, leading to bigger size or looser rules.
Practical defences: a written trading plan, a daily or weekly loss limit after which you stop, a rule to reduce size or pause after a run of losses, and a trading journal that records whether you followed your rules.
Pre-trade checklist
- I can explain why I am taking this trade, and it fits my written plan.
- I know where the stop loss goes and why the idea is wrong there.
- The money at risk is within my fixed risk per trade, calculated from the stop.
- The target and the risk:reward make sense, and I know the break-even win rate.
- I have counted spread and other costs, and checked for major news coming up.
- Total risk across open trades, including correlated ones, is within my limit.
- There is enough free margin for this trade and for losses on it.
- I am not trading to win back a loss, out of boredom, or above my daily loss limit.
Common mistakes
- Choosing the lot size first and the stop afterwards.
- Trading without a stop loss, or treating a stop as a guaranteed exit price.
- Letting available leverage or free margin decide how big a trade is.
- Judging an approach on a handful of trades or on win rate alone.
- Ignoring costs, especially on short-term trades with small targets.
- Holding several correlated trades and counting them as separate risks.
- Changing the rules after every loss, so results cannot be reviewed.
Education, not advice. This guide explains general concepts with illustrative numbers. It is not a recommendation to trade or a suggestion of how much to risk. Currency trading, especially with leverage, carries a high risk of loss. Read the risk disclaimer.