Great question.
We have to make another assumption. We'll need to assume that you have closed the trade and were down by 25 pips. In that case, at $10 per pip, your drawdown would be $250 (25 pip loss X $10/pip).
Now let's say you've decided to risk 10% of your account per trade. Let's walk through an example.
1. You look at the fundamentals (which is your strong point and my weak point) and they say the eur/usd should go up.
2. You look at the chart and it's at a significant level of support.
3. You also look at the chart and see the next level of resistance is 100 pips to the upside.
4. You feel confident that this pair will go up and decide that risking 25 pips is reasonable. If the pair breaks more than 25 pips below that significant level of support, you were wrong about the direction and are willing to take a loss.
5. We're risking 25 pips to gain 100 pips for a 4:1 profit/loss ratio.
6. Your account is $10,000 and we can risk 10% because that's part of your business plan (trading plan) which comes out to a $1,000 risk.
7. Since we're setting our stop loss at 25 pips...then we're only risking $250 per currency lot. We can therefore invest in 4 currency lots which will require $4000...or 40% of your usable margin...but we're only putting $1,000 of the remaining portion of our usable margin at risk because of where we're setting our stop loss (25 pips X 4 lots = 100 pips X $10 per pip = $1,000).
So what I mean by 10% being somewhat aggressive is this:
A lot of folks look at how much money they're going to make in a trade. In the example above, 4 currency lots at a gain of 100 pips per lot = 400 pips X $10/pip = $4,000 potential gain.
However, is the person willing to take a drawdown of $1,000 if he/she is wrong? In my particular case, my first question is NOT how much can I make...but rather...how much will I lose if I'm wrong and can I live with that? And does the potential reward far outweigh the risk I'm having to take to get it?
That's a question that's answered mainly by experience in the market. Once again, a lot of professionals consider 5% to be very aggressive.
It just depends on the individuals tolerance. The tendency for a lot of folks is to risk more when the account is relatively small...and become more conservative as the account grows.
I hope this example helps. Feel free to ask for clarification if I wasn't very clear.
