Why do people recommend risking 2% per trade?

It seems to be common consensus that 2% is the “ideal” amount to risk per trade. I’ve plugged in various values in my excel spreadsheet to see what happens when you change risk and risk:reward ratio.

In my test case, a run of 10 consecutive losses are followed by 10 consecutive wins. This is meant to represent a strategy where win% = 50%, so the probability of 10 consecutive losses are the same as 10 consecutive wins. Risk:reward is 1:2.

The optimal risk per trade turned out to be 25%! If you started out with $10,000, your account would be reduced to $563 by your tenth losing trade. Sounds awful, right? However, if this is followed by ten consecutive wins, your account will explode to $32,000.

On the otherhand, if you only risk 2%, your account will drop to $8,170 by your tenth losing trade. If this is followed by ten consecutive wins, your account will climb to $12,000.

Thoughts? This seems to fly against the prevailing wisdom.

Hey,
I am new to this trading world, but i think i know what your problem is. You consider 20 trades a relevant sample size , which i think it is not the case at all. As i said, i am new to this but i think you should be focused on longterm optimization. Try and re tweak the number of trades and tell us the result.

Well this was a conceptual test so whether I trade 20 or 40 shouldn’t matter. But I decided to extend it, i.e. 20 consecutive losses at 25% risk will reduce your account from $10,000 to $31. However, 20 wins will then turn $31 to $105,000.

Now, perhaps the reason why people recommend 2% instead of 25%(!) or some other high figure is to allow yourself to optimally trade from a psychological level. Many people would consider their account “wiped out” at $31, or even $5,000 and give up.

I’m not sure how you did your math, but it doesn’t sound right. The problem with large risk is not that you will blow your account…if you have a positive win ratio and proper r:r, chances are slim. The problem IS, every time you take a loss your balance is lower.

So, if you are risking the SAME PERCENTAGE on the NEW LOWER BALANCE on the next trade, you will have to take a SMALLER POSITION…less lots. Now you will have to make more pips, or more wins then your losses JUST TO GET BACK TO BREAK EVEN.

So think about the downward spiral of having to win “more” after taking some losses just to get back to where you started. If the risk is small…the change in position size after losses is minimal…or none if you tend to round things off like me lol.

I think you have to call Larry williams for that :slight_smile:

Thanks for your reply, Pete. I really appreciate it. I agree with your logic and that’s why I’m still trading conservatively. But these numbers I calculated are compelling. I think what’s happening is that with consecutive losses, the ABSOLUTE loss is decreasing each time I lose. But with consecutive wins, my ABSOLUTE gain is increasing exponentially. Summing these two figures together will lead to a large surplus.

Here are my calcuations if anyone wants to take a look at it (it’s a google doc spreadsheet).

I think that s true only if the R:R is 1:1, but he has 2:1 in his example.
Now i’m intrigued also King ! thanks for that :stuck_out_tongue:

Okay I’ve put up a protected version of the spreadsheet in case people trash it. :slight_smile:

I’ve also provided a comparison with an evenly-distributed win/lose pattern. It provided the same result i.e. with 25% risk and $10,000 starting capital, you end up with $105,000 after 40 trades. So the sequence in which you hit your wins and losses doesn’t seem to matter. Weird huh?

edit: in conclusion, the recommendation of 2% isn’t to protect you from going bust ???

Nothing wrong with the maths. If you are risking 25% to gain 50% and your win ratio is 50% then your account will grow very quickly. The trick, of course, is getting a win ratio of 50% with a 2:1 R/R. Assuming that you leave your trades open so that they either either fully win or fully lose getting half your trades to go that extra double distance in your favour to win compared to those which only have to go half the win amount to lose is no simple matter. If your win ratio dips a little so that you overall win 3 and lose 5 out of every 8 trades then your 40 trade sample will turn $10,000 into $3,295. You need about a 41% win ratio to breakeven over 40 trades.

Try it with $100 and see how it goes?

Why not just take the $31 as your starting balance. This would give you 10,000/31= 322 chances to get 20 wins in a row.
You make it sound like 20 consecutive wins are right around the corner with a 50% win rate system, so just getting it to happen ONCE in 322 tries should be a piece of cake! and the results would be a Ten-fold increase on your starting capital of $10,000

Genius, right?? :wink:

edit:
I was Wrong! I forgot you are ‘only’ risking 25% of your balance. So 25% of $31 is $7.75

This means you get 10,000/7.75 = [B]1290 chances[/B] to get your 20 consecutive wins. Just remember that if you have a loss, you have to restart back at $31. But if you are above $31 when you take a loss, that means you are withdrawing profit… which in turn gives you more chances to try and get the 20 consecutive wins!!

The chance of 20 consecutive wins or losses is 0.5^20 = 0.00000095. Very very unlikely. :slight_smile: What I was attempting to illustrate is that even if you run into that nightmare scenario of 20 consecutive losses, with enough trades, you have an equal chance of scoring 20 consecutive wins which will recover more than you have lost. Thus risking 25% does not = wipeout. I’m not suggesting that people risk 25%. In fact I’m looking for arguments NOT to since it seems most people recommend 2%. What is the reason behind 2%? It’s not to protect you from wiping out since you won’t wipe out at 25% per trade.

I think the reasons why they recommend 2% Risk is to teach the new trader the psychological and the emotional aspect of it. It will also teach you how to protect your capital once you realize the loss. Trading is about protecting your capital… 25% is a very very high risk for someone who is just starting out …greed and fear will definitely play out once you take this kind of risk…

To be successful trader, consistency is the KEY not by how big the risk that you should take…

Good luck…

Nice observation King Kaiver.

I am also curious about it.

Will be doing similar tests on my system.

2 weeks ago, I made 4 consecutive losses, the week after, I surprisingly logged in 6 consecutive winners.

I used to think this type of scenario was impossible, but it is POSSIBLE!!!


Interesting analysis but I think you are missing the obvious that a 50% win ratio does not guarantee a win every second trade or 20wins after 20 losses. What if you had 20 losses then 5 wins then another 10 losses? At 25% your account would be wiped out before the law of averages allowed it to recover.

It’s an interesting discussion, but for me even within a consistent strategy one could not be sure to hit the 2:1 R:R every time, things happen in the market. And if your run of 20 losers became 25 losers, say, then the stress of seeing your balance that low might affect one’s ability to trade mechanically. A lower risk per trade means that one is dealing with a lower risk, higher probability overall, which should help the psychology of trading mechanically. I would rather build steadily (and frankly, my 1% risk per trade still adds up nicely) than risk a large account dropping to pennies at any point, I’m not sure that I would still be trading mechanically at that point so I could throw out my whole strat.

Also, I prefer to calculate my risk per trade once a month, keeps things simple, rather than between trades.

So I absolutely see where you are coming from, and you’re probably right - but in the real world I find a less exciting path to riches easier to tread lol.

ST

Rud 14
Newbie
Some people are rich because they are clever, thats not me, so I am only asking! Is risk not relitive? If your sl is say 5pips and you risk on the one hand 2lots or on the other 50, then you will lose 10 or 250. BUT, with lot of 2 I need 145pips to make 250, with lot of 50 I need 5 pips to make 250, what is more riskier? just asking where do I miss it.

I’ve made a short C++ program to find out whats the most profitable risk percentage IF YOU REALLY ARE ABLE TO PULL OFF A 50% WINRATE AND 2:1 REWARD:RISK (this is the bug in this idea i guess)!

Considering your parameters (50% win ratio) ,I think it all comes down to the formula: (1-RISK)(1+REWARD) = Average trade result, which happens to be maximized when the risk = 25%. In your example the average trade would return 0.751.50 = 1.125 / trade.

Results are listed below:


Hey, check this out, read it, and then tell us if you still have any unclarities :slight_smile:
Calculating Position Sizes | Position Sizing | Learn Forex Trading

LOL?
This assumes that you can gain 50% of your account’s value with every win. Apart from the fact that you won’t even be able to open a mini lot with 31 bucks (assuming a maximum of 1:200 leverage, which is not a good idea in itself), this is as improbable as flying to the moon by flapping your arms very fast.

Again risking 25% of your 31.71 dollars you’ll be able to open 14 nano lots (again assuming a suicidal 1:200 leverage); to gain 15.85 dollars (50% of 31.71) price will thus have to move about 113 pips, while your stop-loss is at around 56 pips … good luck with pulling that off 20 times in a row, mate.

There are several other issues that will give you trouble, but which I won’t bother elaborating now.

I’d advise you to employ proper money management … while 2% aren’t a must, you definitely should not risk more than 5% on any given trade (this includes scaling into winning trades).

O.

Larry Williams pretty much says the same thing and he mentions that he uses 20% risk on trading.