Roman, the following is for you too.
It is simple, Gyva, once you figure it out. I have to smile because it was only last year that I was where you are now. I spent many a night pacing back and forth on my patio before the light finally came on. (Not the patio light, the light of understanding) And it took more than the pacing. It took drawing two accounts down 90% to finally figure it out. Read what Fiji has posted over and over as many times as needed to gain understanding. I'll try here to put my spin on it, but I can't say it better than what Fiji has already said.
Stops will not protect you from leverage that is too high. It will actually hurt you by depleting your account faster. Why? Because in order to reduce the amount of dollars lost, you will have to set a stop loss that is smaller than the technicals for that trade allow. The odds of your stop getting hit increase enormously. You will get stop after stop after stop, until your account is decimated.
The correct sequence is this:
FIRST Determine your stop in pips,
SECOND determine your position size based on percent risk and
THIRD see what your resultant leverage is. If the resultant leverage is too high, then lower your percent risk for the given stop size.
Notice that leverage comes LAST not FIRST. If you put leverage first you are jeopardizing your account. Let me attempt to illustrate with a couple of examples.
The Correct Way (Trader 1)
Account size = $10,000
Currency = EUR/USD (just so I can use simple numbers)
Stop (based on technicals) = 30 pips
Risk = 2% of your Account = $200
Lot size = Mini = 10,000
Pip value for a Mini lot on EUR/USD = $1
Stop of 30 pips / $1 per pip = $30
Position size = $200 / $30 = 6.67 mini lots.
Since you cannot trade fractional lots (forget Oanda) you must round the position size DOWN to 6. Always round down to be more conservative.
True Leverage = Position Size / Account Size = 60,000 / 10,000 = 6:1
This level of leverage is too high if you lack experience. Better to reduce your percent risk from 2% down to 1%. That will reduce the leverage to 3:1 in this case.
The Wrong Way (Trader 2)
I want to get rich fast, so I want $50 a pip. Therefore, I will trade five standard lots of 100,000!
Leverage = 500,000 / 10,000 = 50:1 (Yeehaw! Now we're cookin'!)
Risk = 2% of $10,000 = $200
Okay, let's see, $200 / $50 per pip = a stop size of 4. Huh? Shoot! My broker wont let me set a stop size less than 10 pips. Aw what the hell! I'll risk 10 pips times $50 per pip for $500 risk. That's not bad. It's only 5% of my account. I'll go for it 'cause I KNOW this trade is a hot one!
Thirty seconds after this trade is placed, the market moves violently in the WRONG direction due to a terrorist bombing in Toledo. Bye bye $500 + spread.
Fast forward. Both traders have had a bad week. They've each placed 5 losing trades in a row. The score?
Trader 1
Starting Balance = $10,000
Ending Balance = $9,000 (neglecting spread)
% drawdown = 10%
% gain needed to recover = 11.11%
Trader 2
Starting Balance = $10,000
Ending Balance = $7,500 (neglecting spread)
% drawdown = 25%
% gain needed to recover = 33.33%
Trader 2 has a larger drawdown, paid more in spread and needs a gain THREE times larger to recover.
TO MAKE PROFIT YOU HAVE TO BE IN THE GAME.
TO BE IN THE GAME, YOU HAVE TO HAVE AN ACCOUNT.
WHO'S GONNA BE OUT OF THE GAME FIRST, TRADER 1 OR TRADER 2?
The bottom line is this:
Amateur traders look at how much they can make.
Professional traders look at how much they can lose.
Amateur traders try to increase profits by raising leverage.
Professional traders protect their capital by lowering leverage.
Amateur traders try to make each trade a big winner.
Professional traders know that individual trades (win or lose) are meaningless.
Amateur traders become one of the 95% who lose all their money.
Professional traders become one of the 5% who get rich in the long run
Amateur traders count on luck and hope to win.
Professional traders count on the statistical edge of their trading method to win using low leverage combined with compounding over a long series of trades.
Amatuers lose.
Professionals win.
Which do you want to be?
Back when I was using too much leverage, I knew it, but only reduced it a little and not enough. What changed me? A single sentence from Fiji cautioning me that high leverage would eventually bite me. Why did it only take a single sentence from Fiji? Because I have enough sense to realize that Fiji is where I want to be (His trading success, not the island he lives on, although that would be nice too)
Listen to Fiji, he is offer help for free that no one could afford to pay for if he chose to charge for it. The same is true for all the successful traders on this forum. They don't have to be here. They are here because they want to help. Don't anyone be a fool and not listen to Fiji or any of the others.
If all the successful traders are telling you NOT to use high leverage, then that should be reason enough to heed their advice now without understanding why. The understanding will come later. Take it on faith for now and keep your leverage below 3:1 if you are a newbie.
Here's one more thing using the correct example (for Trader 1) given above, but with varying stop size:
Account Size = $10,000
Percent Risk = 2% = $200
Stop MiniLots Leverage
30 6 6:1
25 8 8:1
20 10 10:1
15 13 13:1
10 20 20:1
It is given that 30 pips is the correct stop for this trade based on technicals (support/resistance, trendlines, pivot levels, fibonacci levels and price action just to name a few).
It is therefore inappropriate to reduce the size of the stop just to get a higher leverage. Yet this is what amateurs do. They say to themselves, Hey! I can risk the same amount of money ($200) and get $20 a pip instead of a measley $6 a pip. I'm gonna do it!
Big mistake. Your stops will get hit more often and will gradually wear away your account over time. Don't do it.
Okay, have I thoroughly confused everyone? Ask more questions if you still don't understand why you do NOT want to use high leverage.
Dial
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Diallist, you've come a long way baby
Great Explaination!
Quinn
I started out with nothing, and I've got most of it left!
