If you’ve spent enough time searching for trading tips online, you’ve probably come across the 2% rule: never risk more than 2% on a single trade. It might be a good piece of advice, but if you use it in the wrong context, it isn’t going to help you all that much.
Many less-experienced traders follow this advice without really thinking much about its implications. A 2% risk limit concerns only one trade. The frequency of trading will affect it greatly. For instance, do you trade 10 times a day on average or ten times a week?
Account size can also affect how you use this rule. 2% of a $50,000 trading account is very different from the same percentage of a $5,000 account.
Ultimately, it’s good to know beforehand how much you are willing to lose in a given day, week, or month.
A losing streak emerges
What might be worse than coming across a losing streak? Not being able to predict when it’s going to end. Losing streaks tend to defy mathematical odds. Ask any experienced trader and you’ll hear a few harrowing stories.
Now, imagine two traders: a day trader who places around 10 trades a day, and a swing trader who averages up to three trades per week. Let’s suppose that both traders start with $10,000 in their trading accounts.
- If the day trader has two losing days, placing ten trades a day with no more than 2% at risk per trade, then that trader is down 31% in two days.
- If the swing trader has a similar bad week having lost on all three trades, that trader is down only 4% for the week.
See the difference? Both followed the 2% rule. But is it really okay to risk losing 31% in two days, as in the case of the day trader? What if the next trading day yields another 10 losses (this type of thing happens more often than you think). It would be a loss of nearly 50%. The day trader would need a return of almost 100% just to get back to the initial $10,000 starting capital.
Setting loss limits on a weekly or monthly basis
The benefit of setting and monitoring your total loss limit—whether it’s weekly or monthly, or whether it pertains to a “total” limit—is not just that it prevents you from losing an exorbitant amount that may escape your attention, but it also forces you to see whether your approach is working or not; whether you’re progressing, remaining stagnant, or performing poorly as a trader.
Pay attention to your bottom line
Here it is in a nutshell:
- Know much much you’re willing to lose on a single trade (e.g. 1%, 2%, or more) based on your total account size.
- Decide on how much you’re willing to lose in a single day.
- Set loss limits for the week.
- Set loss limits for the month.
- Decide what your total loss limit will be before you a) change your strategy, b) switch to a different market, instrument, or leverage model, c) reduce allocations to your trading capital while increasing your passive investments, d) take a long break from trading, or e) quit active trading altogether.
In other words, don’t just watch your trades, keep your eye on the bottom line. No trader wants to quit. But many traders will have to make adjustments. Perhaps it’s worth changing your approach to trading if the current one isn’t working for you. Whatever the case may be, keep in mind that you can’t focus on making money if you’re spending most of your time losing it and re-funding your trading account.
Please be aware that the content of this blog is based upon the opinions and research of GFF Brokers and its staff and should not be treated as trade recommendations. There is a substantial risk of loss in trading futures, options and forex. Past performance is not necessarily indicative of future results.