When I was first learning trading almost 2 decades ago now I was fascinated by all the common rules that it was felt like I was entering some sort of secret club with a special code of conduct things that will traders say or should do about certain things in the market. When i started to succeed on my own I soon realised that most of these things were just equivalent of people sharing bro signs down at the gym, evidence or logic it’s just what everyone else is doing everyone else does it. Overtime I ditched most of those rules as I’m sure you have but there are some of them I’m one of those is a 2% rule. So that’s the rule that states that you never risk more than 2% of your capital on any trades but if you ask people why they do this or try to find good reasons for online you don’t get a good enough answer but that shouldn’t be a good enough reason. So let me share my reasons with you and maybe that will help you to make up your own mind.
I will share my reasons with you and maybe that will help you to make up your own mind and decide how you want to deal with this rule. Whether you want to follow it or not there are three things I want to cover that is the number aspect psychological aspect and the neurological aspect. Let’s get started with the numbers. Ultimately the reason your trade loses obviously otherwise there’s no need to protect anything, now if it was just one losing trade that we were worried about it wouldn’t really matter if we were risking 2% 5% 6% whatever else. The important thing is when you actually go on a losing streak where you lose a few trades in a row, a lot of traders can feel overconfident about losing streaks they think they might lose a few trades in a row but a big losing streak who is in one trade after another without any possible trades is unlikely to happen. At some point during the year so what does this mean if you’re trading well let’s say that you risk the maximum 2% for every trade and let’s say you max out your 2% every single time. I wouldn’t recommend doing because we always encourage you to use dynamic position sizes.
Basically if you risk the maximum 2% every single trade and you lose five trades in a row you obviously have a drawdown of 10%. This means if you want to get back to breakeven your account is down 90% of what it was before you need to return of just over 11% to bring it back to break even. Not really such a big deal really if your account is always larger than the amount you lose anymore so that’s pretty straightforward but what if instead of risking 2% you now risk 3% per trade. Well now after five losing trades the drawdown is 15% so that means you’re going to need a return of 17.6% to get back to breakeven. This is why you should stick to a 2% risk management at all times. And what about if you risk 4% and now your down 20%! I know I’m impressed with my mental maths here but that’s going to require a 25% return to get back to breakeven. Now if we were only interested in probabilities as traders we might choose to use something like the Kelly Percentage for example or some other alternative to calculate our ideal amount of risk or we can calculate our success rate over the 100 trades in a year. Also see what amount we should risk by trade. But the fact is the probability is all that matters.