The 2% rule

[Hotch]

Hey guys,

Been lurking about these forums for a bit, will hopefully set up a blog come september (bit busy atm).

I figured I'd start off with this post, as i want to know your thoughts (why else would i post i guess).

There is this generally accepted rule of not putting more then 2% of your trading capital into one stock (or deal).

Do you agree? Why? What are the advantages?

Personally, I don't follow it, but i think it might be because I'm missing something major, and as I am rather rubbish at explaining my ideas in text, i figured it would be easier to reply to your views, then hope you'd understand mine.

yay?

P.S. great forum, love you all, etc

Hotch
xxx

 

[Vrothdar]

It's a pretty good guideline for money management at the most basic level. The less you risk per trade the less of an impact a losing streak will have on your account balance and the more likely it is that it'll return to previous levels.

This page on babypips.com gives a pretty good explanation of it.

IMHO whether or not you stick to 2%, 1% or any other figure isn't as important as having a good reason for using that number and sticking to it consistently.

 

[Hotch]

I guessed that was the main reason.

It's less likely that 50 stocks are going to crash then just the one (not that I'm suggesting just one). Also ofcourse if you invest all your trading capital into one stock you have little to do until you close your position.

However, if you open less trades, you have more time to research them before hand, keep an eye on them etc, and ofcourse you may pay less commission (depending on what you're trading).

1-2% just seems rather low to me.

Guess we all come up with our own figures. Guess I'm just lazy, although it is working out fine atm.

Cheers

P.S. Reaslied that it obviously depends on your win %, sheesh, degree in maths and I don't notice these obvious things, I've been steady with my wins and lucky i guess :X

*feels very shameful, this is what comes from being self taught*

 

[wasp]

IMHO whether or not you stick to 2%, 1% or any other figure isn't as important as having a good reason for using that number and sticking to it consistently.

I agree. The risk % should be relative to your performance and expected performance. If you don't expect nor exceed a few losers in a row, then factor that into the risk model. Whilst trading 0.5% of your account is wise money management and makes you sound rich, if it means it takes 6 months to make a 5% account increase and you haven't had a run worse than 3-4 in the past 6 months (nor expect to and have a plan if such situation arose), then use a larger %. IMO.

Everything is relative to you and your trading style. Personally, my aim is to make money!

 

[Vrothdar]

It's less likely that 50 stocks are going to crash then just the one (not that I'm suggesting just one).

All it takes is a black monday or 9/11... You wouldn't need all 50 stocks to crash to effectively wipe you out.

Risking 1% of your account would usually be calculated using the difference between the price you enter at and the price you'd exit if the trade was going against you rather than current price and £0.

 

[FXSCALPER2]

Risking 2% regardless is nonesensical. Remember that the reason for these low risks is psychological.

 

[0007]

Risking 2% regardless is nonesensical. Remember that the reason for these low risks is psychological.

Agree. I suspect that Van Tharp & Elder have a lot of responsibility for this. They're in the market as trainers, there's no student entry exam so you have to have a safe catch-all rule that's easy to understand & implement.

Wasp's got it right at #4

 

[Jabel]

Hi there

Personally, I work out the number of trades I'm likely to make in one day - say 4 on the emini, and then divide 2% by the number of trades, so that I'm actually risking just 0.5% per trade, and no more than 2% per day. Going one step further than this, I then enter my initial entry point and stop level into a spreadsheet to determine what size I can trade based on the above rules. I think its better to do it that way, and pick a stop level based on market data, rather than one based on the $ amount you're prepared to lose. Despite all this, however, I can't seem to make money (although my losses are manageable), so any help would be greatly appreciated!

 

[abottoml]

My understanding is that the 2% rule is what is advised to beginners only. Note that 2% means the capital at risk, not the trade size.

In terms of more advanced money management, you need to know your own personal values for these two variables:

1. Win probability - The probability that any given trade you make will return a positive amount
2. Win/loss ratio - The total positive trade amounts divided by the total negative trade amounts

So assuming that you have assessed these accurately (and always be wary of your assumptions), you can use the Kelly Ratio formula to calculate the optimum risk per trade:

Random Portfolio Simulator

More here:

Money Management Using the Kelly Criterion

 

[Mr.J-Arthur]

Risk it all, but set stoploss @1-4% loss of total account. You would have to lose 100 trades @ 1% and 25 trades @ 4% to blow it all, but if you be selective and you choose your trades wisely, that shouldn't happen. Most traders can find a FEW good trades out of 100 I would think

The larger your drawdown, the larger your gains must be. Thus keep it small and keep profits big.

My account (and many other accounts) out there don't have 100k...so to only risk 1% on a 5k account would be $50! You cannot make any trade with that amount, but you can set a stop loss to $50 for a 5k account and that's an acceptable loss.

If you find a good opportunity, risk it all and set stoploss...let profits run and you'll greatly improve.

 

[new_trader]

You would have to lose 100 trades @ 1% and 25 trades @ 4% to blow it all.

No, incorrect. That's not how % works

@4% risk it would take 17 trades to reduce your capital by 50%

It would take another 17 trades to reduce capital by another 50%

34 trades so far! :-0

etc..

 

[Naz]

I think Wasp is right when he says

"Everything is relative to you and your trading style."

I'm a US day trader and my love is quick early momentum. I'm afraid that my risk is the immediate risk I see on my screens and not a %ge value.

Alan Rich

 

[timsk]

Hi Alan,
Great to see you again. Had we known you were going to make an appearance, we'd have got the red carpet out! Good to see you here - any chance of you posting some recent trades?
Hope we can tempt you to stick around!
Cheers,
Tim.

 

[Naz]

Hi Tim,

I've just finished trading for the evening. I'll try and stay and post when I can. If not most of my opinons and trades are in the news section of my web site.

A trade from last year for you 1,650 spread points in 59 seconds. A BIDU results play using level 2 direct access.

and 33% in 3 mins on DNDN, I used the story and level 2 to get a feel for the momentum pre market and hit it on the open, when it was obvious they wanted to take it for a run, I jumped out when it died at the highs before the chartists could see it.

BIDU is just a hot momentum US day trading stock that I watch every day and it went on the morning run. This was nice and gentle 2,100 points in an hour and 20 mins. That was pure momentum, all I did was ride the wave.

This one is a sensible one and is to do with my account. I start the day and just cant get off the mark, two small losses and I'm going nowhere, so I do nothing but watch and wait, then I catch the big one for nearly a thousand points, after that I cant get going again and I pack up. only 4 day trades and 5 hours into the day. If I hadnt got that big one I would have walked away for the day. Just understanding it wasnt my day and keeping any losses minimal.

 

[timsk]

Hi Alan,
Thanks for the charts and an insight as to how you trade. These trades - and the MA trade you mentioned on the coaching thread (link below) - strike me as being solely the domain of very experienced direct access level II players like yourself. Fantastic profits if you get it right; big losses if you get it wrong! I say this because you mentioned on the other thread the possibility of making these trades via a SB account. Given that many SB accounts tend to be quite small and often operated by traders with limited experience, I wonder just how suitable stocks such as BIDU and MA are for these traders? I'm generalizing a bit I know but, even so, I would be reluctant to trade these instruments myself with a reasonably funded D.A. account, if only because of their massive volatility. I use ATR to measure volatility and decide on position size accordingly; these stocks are so far off the Richter scale that I'd only be able to take miniscule positions of one or two shares per trade! This isn't an option for most SB traders, trading at £1.00 per point.
Tim.
http://www.trade2win.com/boards/first-steps/35906-anyone-looking-coach-me-fee.html

 

[Newtron Bomb]

Personally I like to work on a worst case senario for my risk.

This means that I have worked out what 2% of my account that I'm prepared to risk on each trade and as I'm trading FX I'm prepared to take up to an 80 pip risk.

So I have a fixed position size based on this.

In reality I'm trading a lot less than 2% per trade and normally between 0.5% and 1.5% per trade.

This meant that I dont have to worry about my position size for each trade or trading day/week. It also helps me keep a smooth equity curve both up and down.

Most of trading is down to personal preferences and this keeps life a lot simpler for me. It is by far not the best way to effectively manage an account but I like it.

The main idea behind risk management for my account is not to be able to make money today but to able to place a trade tomorrow, Particularly If I have a bad run.

Risk is about surviving, LONG TERM. Short term you can double and triple your account with poorer risk control and you can easily halve and halve your account in the same way.

My Mantra in this regard is "Today doesnt matter as long as I can place a trade tomorrow"

 

[Splitlink]

Hey guys,

Been lurking about these forums for a bit, will hopefully set up a blog come september (bit busy atm).

I figured I'd start off with this post, as i want to know your thoughts (why else would i post i guess).

There is this generally accepted rule of not putting more then 2% of your trading capital into one stock (or deal).

Do you agree? Why? What are the advantages?

Personally, I don't follow it, but i think it might be because I'm missing something major, and as I am rather rubbish at explaining my ideas in text, i figured it would be easier to reply to your views, then hope you'd understand mine.

yay?

P.S. great forum, love you all, etc

Hotch
xxx

Let's say that. from my own experience, 2% is not written in stone but, if I had traded much more than that I would not be able to trade now. In fact, I would have gone down the chute decades ago.

You can't be right all the time. I've had such a run of bad trades in my time that I've wondered whether the devil, himself, wasn't taking a personal interest in my financial ruin!

 

[normbeef]

Horses for courses...

I think most traders with a small amount of capital struggle with protecting it simply because they seem to dislike trading small amounts, and only making a few quid when they win..

it does take a very long time to build a decent amount of capital by starting with say £1000..

Using leverge to swell the risk is one option, but it quickly takes you away from low risk, which after all is what we all want surely ???

percentage risk to trading capital = Size of the stop loss (in Currency) £ - expressed as a percentage of the total account size

 

[Naz]

Hi Guys,

Nice to see the old faces are still here.

Tim I understand what you say and I have addressed your argument with some special charts I designed. You are very welcome to e mail me and I'll gladly show you how a spread bettor can go for the bigger moves now. Infact i will show you a 800 point move on MA yesterday using them. In all honesty I am opening a spread bet account myself to take advantage of these big moves on the high priced US stocks.

If you havent got my e mail use the contact page on my web site.

Do they work?, Well the hardest tasks were to beat some ES day traders just round the corner from Wall St, they sat gobbsmacked while I beat their analysis and caught the big run. I'll send you that chart as well.

Proving their worth for contoling risk infront of a complance officer whilst using them on Live markets.

Spending a whole day having them analysed by the Editor of what really works.

Having them used for six months by about 60 traders I know and being given the thumbs up.

Naz

 

[Naz]

I sent Tim the 800 point move with my charts and also the 900 point move last night on MA. A daily update on the US indices is one my web site. I've also written up how the entry to MA was found last night. Click on NAZ at the top of this page and visit Naz's web site it will then take you there, if your interested.

That is momentum trading . Let the move start cut your risk to zero and ride the wave with the markets money.