The Sensible Guide to Forex: Safer, Smarter Ways to Survive and Prosper from the Start

APPENDIX E

How the Mathematics of Loss Demands Keeping Losses Per Trade Low

As noted at the start of Chapter 5, losses hurt you more than gains help you. This is true from both a financial and psychological perspective.

First let's look at the financial side. Losses do disproportionately greater financial damage because in order to recover your losses you need to earn higher returns with a smaller capital base.

For example, let's say you started the year with $100,000 and lost 20 percent, or $20,000, over the course of the year. You now have $80,000 left. To recoup that $20,000 or 20 percent that you lost from your remaining $80,000, you have to make 25 percent on that $80,000. However, if you'd gained just 10 percent over the course of the first year, you would only need a 9 percent return over the coming year on that $110,000 to add another $10,000 to your account.

Which of the two possibilities is more likely? A 10 percent gainer earning 9 percent or a 20 percent loser gaining 25 percent?

Do you see how losses hurt you more than gains help you?

I recommend not risking more than 1 percent to 3 percent per trade. In other words, if you start with a $20,000 account, your stop loss should be close enough to your entry point so that if hit, your loss won't exceed $200 to $600. Assume you follow my advice and risk 2 percent on average.

Here is a more detailed illustration of the difference between risking that 2 percent of your capital and risking 10 percent.

Imagine two traders ...