May 24: Professional Traders Never Risk More Than 2 Percent … Do You Know Why

by Dave on May 24, 2006

Studies have shown that you should never risk more than 2 percent of your float on any trade. Why 2 percent? Well, in fact, many professional traders will tell you that 2 percent is too much. They`ll risk 1 percent or even as little as a quarter of a percent on any trade. Whatever percentage you pick, the idea is to ensure that no one trade is really going to affect your trading float, positively or negatively.

Many traders don`t appreciate how powerful this rule is. By simply changing the amount of capital you risk, you can turn a system from returning 10 percent to returning a 100 percent per annum. Now, by increasing risk, and investing more in a trade, you do increase your chance for reward. However, you also end up increasing your draw down as well. You may want to do a bit of testing to fully understand the importance and the power of changing this one variable. I always recommend that you never exceed a 2 percent risk, but it can be a difficult to understand the difference that keeping your losses small can make to your trading.

Let`s look at an example of the 2 percent rule in action. If we had a trading float that was $20,000, using the 2 percent rule we set our maximum loss to be $400 on any one trade. With this maximum loss, we could have a string of 50 losses in a row before we had no more capital left to trade with. In most trading systems the chances of getting 50 losses in a row is very, very slim. However, the chances of going broke are even smaller, because when you implement the 2 percent rule correctly, the calculation is based on the current float size.

So, initially 2 percent of $20,000 is $400. However, if we experienced a loss first off, our trading float would now be worth 19,600 dollars. We then calculate 2 percent of this new value, and set our maximum loss for our next position. 2 percent of $19,600 dollars would be $392. You can see that each time we experience a loss, our next maximum loss would shrink. As our portfolio increases in size, we`re happy to take on more risk as well.

I thought I`d play around with a few of the figures just to see what would happen if we had a string of six losses in a row. After receiving six losses in a row, our trading float would have decreased to only $17,717. After six successive losses, we`ve only lost $2,283. Now, that`s managing your risk.

The fact that the loss is such a small component of our trading float makes it much easier to gain back those losses. In this example, we`ve lost a little bit more than 10 percent. To gain back that loss and break even, we`ll need to make 11.1 percent. Now, imagine if we didn`t have good money management in place and we had a draw down of over 50 percent. If we have a draw down of 50 percent and we loose it, we need to make 100 percent return on our remaining capital to break even. You can begin to see the how a larger draw down makes it more difficult to recover from losses.

Novices often risk more than 2 percent. Even if you`re starting out with a small trading float, you should practice good money management. You need to position yourself so that you can endure long strings of losses, and maintain your trading system. When the market does turn around, you`ll be in the market positioned to capitalize on it`s moves. That`s what setting the maximum loss is all about, it keeps you in the market, allowing to you to keep your trading system going. If you can survive while some losses while trading, the profits will come.

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This article has been extracted from David Jenyns` Trading Secrets Revealed Course. Unfortunately this course is currently sold out. To be notified if and when extra copies are released, please send us an email and we`ll let you know when you can purchase a copy of this highly recommended course. Click Here and send us an email. and be sure to mention you want to be on the `Trading Secrets Revealed Waiting List`.

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