2% or not 2%

tomorton

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#16
In some shape or form you must control losses and be able to stand an extended run of losses without fatal damage to your account (losing 50% of your account means you have to gain 100% with what remains just to get back to where you started).

2% is as good a rule of thumb as any.

Cheers Jon, this relates back to Elder's original trading model. An extended run of losses on long positions would most commonly be triggered by a rotation of the underlying bull market into a bear phase. Elder was writing for medium-term traders who were going long only, so even fantastically good portfolio management and stock picking couldn't protect them from a bear market. A much more likely event than a black swan.

But we're able to go long and short on instruments in the same class, so a rotation from bull to bear isn't to us what it was to him and his original readers. And its the original readers he was writing for, buyers of his book who were active in the 1993-4 stock market, not some guys in another country 20 years later using spreadbetting and goodness knows what else.

Surely for long-only EOD traders 2% might be prudent, but long-and-short traders should double it to 4% at least? And that's assuming the rule is even correct, which I'm not convinced now that it ever was.
 

barjon

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#18
Cheers Jon, this relates back to Elder's original trading model. An extended run of losses on long positions would most commonly be triggered by a rotation of the underlying bull market into a bear phase. Elder was writing for medium-term traders who were going long only, so even fantastically good portfolio management and stock picking couldn't protect them from a bear market. A much more likely event than a black swan.

But we're able to go long and short on instruments in the same class, so a rotation from bull to bear isn't to us what it was to him and his original readers. And its the original readers he was writing for, buyers of his book who were active in the 1993-4 stock market, not some guys in another country 20 years later using spreadbetting and goodness knows what else.

Surely for long-only EOD traders 2% might be prudent, but long-and-short traders should double it to 4% at least? And that's assuming the rule is even correct, which I'm not convinced now that it ever was.
Well, I can trade both ways but that didn't stop me having a losing run of 9 earlier in the year.

I don't think you can say whether the rule is "correct" or not, it's just a rule of thumb that gives you a decent chance of staying in the game a lot longer than you might. In trading contests the winners have often gone "all in" most of the time and scored untold paper riches. For the one lucky "all inner" ther are 99 who have blown out of course :LOL:

People, particularly beginners, often concentrate on how much they can win (hence not liking a low stake/low risk rule) whereas the longer toothed focus on what they can lose and control that.
 

tomorton

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#19
Well, I can trade both ways but that didn't stop me having a losing run of 9 earlier in the year.

I don't think you can say whether the rule is "correct" or not, it's just a rule of thumb that gives you a decent chance of staying in the game a lot longer than you might. In trading contests the winners have often gone "all in" most of the time and scored untold paper riches. For the one lucky "all inner" ther are 99 who have blown out of course :LOL:

People, particularly beginners, often concentrate on how much they can win (hence not liking a low stake/low risk rule) whereas the longer toothed focus on what they can lose and control that.

Indeed Jon, going all-in and hoping for luck just isn't risk management. So I guess some form of risk management has to apply, somewhere less than 100% risk per trade. But I'm saying acceptance of 2 is just wrong.

I've got a feeling that Elder was thinking to himself, "Whether I make money trading or not, I want people to buy my book. And my name will be mud if they buy it and go bust." So this has conditioned his rules. He's gone really conservative so that it can be argued anyone who goes bust after following his rules must have just been terribly unlucky, and that's nobody's fault. And I suspect he's also thought to himself that if the bull market ends before his readers had a chance to re-coup their losses, at least they'd have enough money left to transfer it to an interest-paying deposit account. His long-only readers couldn't trade in a bear market but they would still want to make money and hold the ambition to get back into the market.

So he's conditioned them to "not lose" or at any rate to "not lose fast" rather than to win. Alright, as a new trader, preservation of capital is key. But a 2% cap isn't from the real world, its from the unproven author's world. And for experienced traders, surely 2% is suicide?

The crime here isn't the advice, its the blind acceptance, and I admit to being an accessory here.
 
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Atilla

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#20
Agree with much of what has been said.

I would add along with the MM system of 2% Risk / x% Reward???

One must also consider:

- ATR of instrument
- Volatility
- TF and
- Type of trade entered ie. scalp or swing


Alternatively, if we are sticking to the 2% risk rule then make sure instruments selected for trade lend them selves favourably to such a rule & TF. Not all instruments move the same.
 
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tar

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#21
The rule is not wrong it is just a rule of thumb to survive in this business , technically if you are scalping with tight sl then 2% is a lot ...
 
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sminicooper

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#22
This is an interesting thread and some very relevant points have been raised - the sort of things that new and inexperienced traders should take note of and look into further if they are not already doing so. I believe the "2% rule" is more guidance than absolute; when you look at its origins (the famous big-name trainers of this world?) you can understand why it assumes significance. They are all in the business of making their money from training and it is not good for your business to say that (as we all know) trading is a simple concept but very difficult to execute skilfully and successfully. So they simplify the rules, and the subtext is that no matter how stupid or brainless or inexperienced you are, you can be a successful trader quite soon. What a load of tosh!

Nevertheless all beginners have to start somewhere and the 2% rule is probably as good as any while they are at the stage of not knowing or understanding the deeper meaning of risk. The paradox is that the more experienced and skilful you become, the less you will probably risk and with a large account 2% is probably way too much. I believe that the skilled and experienced trader knows when to increase/decrease risk just like an F1 driver will know how fast or slow he should take a corner according to prevailing conditions. But there are so many factors which go into the make-up of overall risk: long ago I used to think it was quite simple – just a question of putting the right figures into the spreadsheet and out would pop the correct answer. Perhaps that's the trap that many beginners fall into? I've spent ages studying risk (I used to doubt the "10,000 hours study required to become proficient" mantra) but I now feel it's true more than ever. So in my opinion, beginners really need to hoist this "risk" thing on board. There are so many aspects to risk and many of them have already been mentioned – they all need study.

One of the things that I've never seen mentioned in textbooks is that you don't need to keep your all your funds with the broker – just enough to service your trading needs seems to me to be a far more secure prospect. And then there's the question of stops: do beginners really understand their purpose and how to use them, even before going into the thorny question of where to place them? In my book, usually if a stop gets triggered then it's a failed trade and most likely my own fault for letting it progress too long. On the other hand, it could be a black swan event in which case you might be very glad you opted for a guaranteed stop. One problem I read about is traders who nominate a stop with their brokers (after due consideration et cetera et cetera on position) and then find it's taken out during the course of a trade which would have ended up being profitable. The only way I have found to counter this (and this comes automatically with guaranteed stops because they are usually much wider than what you would nominate yourself) is to fix your own mental stop (which neither the market nor the broker know about and cannot therefore be held responsible) and exercise it rigidly – and still make sure you know to get out before it's hit if the trade is a dud. But that will take some psychological training and practice!

These are the sort of things I learned through experience and never knew as a beginner. I suspect there must be lots of other nuances that you pick up with experience and become ingrained in your trader psyche without you realising. This surely is where a really good trainer or mentor will come into their own if they have a tyro under their wing and are somehow able to pass this stuff on. To a certain degree I sympathise with trainers because they must inevitably acquire students of whom it soon becomes apparent that they will never be traders. It must be difficult to admit that you can't train them when many others are standing round the corner who say they can, and it must be even more difficult to refuse their money. But of course, that's another characteristic of the trading world isn't it? – The money often distorts the facts.
 

Signalcalc

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May 21, 2016
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#23
This question looks to be quite subjective, so here's my subjective view:

2% is probably too high for beginner traders that don't know how their strategy performs or have a trading plan. Also 2% doesn't suit all trading styles such as scalping, so it's not a one size fits all approach.

I trade intraday, set and forget on the stops, they do not move, I don't stop out early either or move to BE, I only move my targets in if the trades are going beyond a day.

So I've taken some inspiration from Maza and an article he posted about a combined fixed ratio/fixed fractional approach, to make the most of this approach you need to know how the strategy performs over time, such as max drawdown, margin requirements, max number of trades and so on, from there you can work out max percentage.

For me max percentage is around 2.5% per trade, at that level if I have max trades on at any one time I know that I would be risking no more than 30% of the account across all trades with it's associated margin requirement and max drawdown of my strategy is around 800 pips, combining max trades/max margin and max drawdown I know I'll never have a drawdown of more than approx 50% of the account, this combined scenario is rare, I'm happy with this approach as even with this scenario I know what the average monthly profit is over time.

However I am taking it in 0.25% monthly increments to reach 2.5% and I'm currently at 1.75%, as I need to be comfortable with each increased risk level, otherwise I know I would start to sweat if I went straight to 2.5% and ended up with the aforementioned scenario right off the bat and sweat trading doesn't work for me :D

Mazas article:

Mazas Combined fixed fractional/fixed ratio Money Management

and one of the threads Maza has posted:

Maza thread
 

Charlton

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Nov 23, 2003
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#24
First I would like to point out that risking 2% of your equity capital per trade is not exactly what Elder said.

In his chapter on Risk Management (page 260) he states “Extensive testing has shown that the maximum amount a trader may lose on a single trade without damaging hs long-term prospects is 2 percent of his equity”, which has given rise to the quote.

However further down the page he states “if you have $20,000 in your account, you may risk up to $400 per trade. If your system flags an attractive trade with a $275 risk then you may trade only one contract. If the risk is only $175, then you can afford to trade two contracts”

In other words the 2% rule applies to the TOTAL risk across all your open positions. You should not be risking 2% of your equity on trade 1 + 2% on trade 2 ……+ 2 % on trade 50, because that would generate 100% risk over 50 open positions.

So the best way to tackle this is to decide in advance the maximum number of open trades you will have e.g. 4 positions. Take your capital (say $100,000) and if the risk is 2% then you have a total “allowable” loss of $2000. For 4 positions this is 2000/4 = $500 “allowable” loss per position assuming they all have equal risk. Your aim should be to keep the risk per trade identical.

Now if you divide the above figure (500) by, say, the Average True Range (ATR) as a measure of volatility or “riskiness” of a particular instrument you arrive at a potential position size. The ATR chosen should be for the appropriate period for your trading style. Different measures of risk, apart from ATR, could be chosen instead.

IBM for example has an 14 period ATR over a 30 min period of 0.41 whereas HSBC has 0.11. This means that you could have around 4 times more HSBC shares compared to IBM keeping the proposed risk equal.

Having discussed all this based on the 2% rule, in reality you can choose any percentage that is appropriate for your circumstances. It is probably more appropriate to start with “How much would you be prepared to risk in monetary terms out of your trading capital”. Once this question is answered then you have the percentage.

If your trading capital only represents a minute portion of your total wealth then you might be prepared to risk a percentage much greater than 2%. If your trading capital represents your total wealth in the world (and I hope it does not) then the percentage should be substantially lower than 2%.
 

tomorton

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#25
Well Charlton, I don't have a copy of the book, but I wouldn't interpret the quote you give as meaning what you say.
 

Fugazsy

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Nov 10, 2014
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#26
the 2% will let you stay in the game longer but you will bleed slowly.

I think his main system was called "triple system" some kind of idea to enter with a pull back which make sense in theory but in practice in nowadays markets is just a little more than a flip of a coin.
 

Pat494

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#27
Does anyone still do position building ? By that I mean getting into the market with less than 1% and building up a position if the price moves, by less than 1% increments until it is about 2% overall ?
Many haven't the patience to wait but are well into 2 figures % trying to make their money work for them quicker. High risk with high returns if the calls are any good. Need a good track record to pull off this feat imho
 

NVP

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#28
if you were to look at say 10,000 trades over the lifecycle of a trader (moving from intermediate to advanced ability) and a finite capital base as a starter .......... it will be clear that a very small % allocation will be recommended in the learning phase .........once they get to an acceptable level of ability then its in the lap of the gods guys .........if you go too high on stakes and hit a bad run then you are going to be drawing down big time .........but then again hit a good run and the dollars roll in quicker (albeit off a smaller base initially from the big drawdowns)

all about the sample size ...........and the cahunnas of the trader ...........for me playing the 1-2% epr trade allows me to sleep at nights

there is profitability to be made trading ..........but just don't take the P*ss on how good you are by going into higher % stakes ..........the market will bite you back hard.......

N
 
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Mr. Charts

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#29
Also bear in mind when calculating position size in relation to ATR that the latter figure is capable over any given time period of expanding drastically and disproportionately.
For example a stock with an ATR of say 15 on a three minute candle can easily move through a range of 30 to 45 over one subsequent candle.

Atilla's post
QUOTE "Agree with much of what has been said.

I would add along with the MM system of 2% Risk / x% Reward???

One must also consider:

- ATR of instrument
- Volatility
- TF and
- Type of trade entered ie. scalp or swing


Alternatively, if we are sticking to the 2% risk rule then make sure instruments selected for trade lend them selves favourably to such a rule & TF. Not all instruments move the same." END QUOTE

should always be remembered.
 
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Mr. Charts

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#30
Also, beginners should always paper trade to begin with to make faulty proposed approaches less likely to result in financial loss. Obviously paper trading trading does NOT guarantee success in the real world, but if you can't paper trade a strategy profitably you aren't going to succeed in the real world.
After CONSISTENTLY successful paper trading then a beginner can plan to start with small size in the real world. Personally I would suggest much less than a total risk of 2% of capital. You can always gradually increase that as consistent profit and experience grow.