Why do people recommend risking 2% per trade?

[PaladinFX]

One of the main precepts of successful trading constantly emphasised to newbie traders, is that you should trade forex only ‘with money that you can afford to lose’. If everyone was doing that, one should be able to trade whatever % of their account they liked and to continue to trade mechanically whatever their account balance. This, however, is not the same as trading ‘with money that you [I]plan[/I] to lose’, as I would imagine that no-one trades with the intention of blowing their account.

I would suggest that trading no more than 2% (or a figure close to 2%) of one’s account has been arrived at by empirical means, i.e. the collective experience of all traders over many years trading has resulted in a balance between: a) the damaging psychological element of watching your capital diminish to nothing; b) the wish to realise a positive and worthwhile return on one’s investment risk; and c) staying in the game long enough (protection of one’s capital already alluded to) for b) to be achievable. 2% is a suggested figure and I don’t believe it’s a figure that’s been plucked entirely out of thin air.

The easiest way to approach this is to try it … start with your account at $30, assume your twenty or so consecutive losses, and try to trade your way to profit risking 25% of your account. While an interesting concept, I guess it’s not going to be achievable, but there again $30 is not going to break anyone’s bank … I wish anyone luck who attempts it!

Good post.
Where have you been hiding, hehe?
Only two posts in more than two years …

O.

[dapperdan51]

Hi Oliver … you’re on the ball

Well, for one reason or another I didn’t have the time to devote to learning what I quickly realised would be a very intense and time-consuming ‘pastime’. Since Christmas though, I have both more time and enthusiasm, so I’m busy learning as much as I can, mainly from the Babypips School and Forums, and demo trading.

I’ve read a number of your posts over the last month, which I’ve found useful and insightful, so thank you for that. I hope that I may become more of a regular contributor in the future.

Regards,
D

[PaladinFX]

Yes, I hope so, too … that post was good.
And good luck with your trading.

O.

[MoneyNVRSleeps]

I believe every trade represents itself to differant risk %… IF your lowballin the trade, your not confident in the trade, so why risk even a single penny. When you get to the higher amounts of money your working with, those pennies become heavier, no?

Like yesterday for instance… Report came out, and just dropped, Did you still risk 2% max, even tho, the move was so evident?

IF your losing 20 trades in a row, its time to rethink some things, JMO…

Heck, if I lose 2 in a row, I have to step back, and find the problem ASAP…

But then again, Im risking 5 for 20, at no less then 50% Pertrade.

Its all about trading smart, taking the pips the market gives you, and capitalizing on your moves when they present themselves.

Also, its an individual thing, its about feeling comfortable in your actions. If your happy, keep rockin it, dont change anything.

[PaladinFX]

Like yesterday for instance… Report came out, and just dropped, Did you still risk 2% max, even tho, the move was so evident?

Yes, I mostly agree with that.
If I see a pair really taking off, I’ll sometimes increase my position size considerably, to make the maximum out of the move (worked really nicely with XAUUSD over the past month).
But I still fix risk at 3-5% by just settingv the S/L very tightly … once a pair is really moving in an H1 candle, the risk of fluctuation triggering the S/L is way lower.
I then set a 15-to-20-pip trailing stop (with XAUUSD only) at a few bucks over break even point … that way, I can make the best out of one of the sudden huge moves Gold has made during the last weeks.
In my opinion, this will not work with every currency though; XAUUSD has the advantage of moving in much larger steps, so once it takes off, there’s some real money in it.

O.

[vladul11]

Hey guys.

Correct me if i am wrong but day trading with 25% risk is impossible with a leverage lower than 300-500:1, since with 20pip SL the margin required is more than 100% of equity. And as i found out by researching, most brokers lower the maximum leverage you can use as your balance gets higher. Is there a way around this?

Thanks.

Edit: Btw, if there is a way around this i will make a thread where i live trade with 25% risk and we’ll see where that takes me.

[Buckscoder]

My opinion on the topic: 2% risk sounds not much, but if you have 10 losers in a row you’ll see it hurts more than first thought. 20 losers in a row or even more sound like almost impossible, but what is statistically low probability doesn’t mean it can’t happen, and if it happens it doesn’t help to know it shouldn’t The more trades you have, the higher the probability you hit eventually exceptional uncertain numbers of losses/winners.

A practical approach is imho to plan with the stats for 100 trades. So if you have a 75% chance of a winner then the worst case planned is 25 loser trades in a row. If you have only 50% chance then calculate for 50 losers in a row. Or if that sounds too unrealistic, what about 20 losers, then 2 winners, 10 losers, 1 winner and then 23 losers? That can happen! Take that and the kelly formula and find something in between what suits. The 2% is the general rule, not the specific max. risk per trade for all circumstances. It is also for a novice trader who doesn’t want to be that accurate in calculate the risk on every trade.

What is also more important than risk per trade is max. drawdown imho. Because the max. drawdown takes into account even the situation where you have a few winners in between the strings of excessive losers. If you test a strategy watch that there is some buffer, because the future will not be like the past. Cut the actual max. drawdown risk by 2 and that’s imho the best one can do to be prepared for the uncertainty of markets. Goal number one is to stay in the game and not to become rich quick or feed the brokers consistently.

[PaladinFX]

Goal number one is to stay in the game and not to become rich quick or feed the brokers consistently.

Yep, that’s what I repeat twenty times a day (that and ‘Let compounding work for you’): [I]Capital Preservation is THE RULE for any and every type of investment[/I].

O.

[pipgoestheweasel]

Which ‘[I]obvious inherent psychological element[/I]’ would that be?

The one that you’re displaying in this very post perhaps?

And: anybody not considering trading 25% of one’s capital extremely risky is in sore need of a reality check … especially when assuming 50% gain on every trade to boot.

Would you consider playing Russian Roulette with one out of five chambers loaded risky?
That’s a 20% chance of blowing your head off.
And would you consider the fact that four chambers are empty, thus giving you an 80% chance of survival, an ‘[I]obvious inherent psychological element[/I]’?

Good luck trading 25% on every trade … if you still considered it ‘[I]in fact better[/I]’ than employing sound money management in a month from now, I’d be very surprised … and you’d surely be one lucky guy, to still have a trading account which enables you to do more than buy a pizza.

You’re a prime example of someone who shouldn’t trade 25%, which is also fine.

[pipgoestheweasel]

I’m a good trader, but I think that risking a quarter of my account on a single trade would be crazy, that’s all I was saying. Happy to disagree, just expressing my personal opinion.

To take your second point, to risk 25% on one trade as opposed to, say, 2% obviously does not make that trade any more or less likely to work out well. However over time, the risk of a drawdown doing serious damage to the account is too great for me to think it sensible over time. Others will disagree, that’s all fine. I would take issue with your ‘even though it is in fact better’ but one of the joys of trading is that there are many different ways to approach it, many of which work.

ST

Well you can’t really argue with the maths. But its fine if you don’t feel comfortable trading that amount. Take note though that its no different you saying risking 25% is no good than me saying risking 2% is no good. Anyway I’m just going by the maths. The risking 2% option only works because its ‘not much’ so therefore when you lose, it won’t be much. Maybe not trading at all is the ultimate amount?

[pipgoestheweasel]

My opinion on the topic: 2% risk sounds not much, but if you have 10 losers in a row you’ll see it hurts more than first thought. 20 losers in a row or even more sound like almost impossible, but what is statistically low probability doesn’t mean it can’t happen, and if it happens it doesn’t help to know it shouldn’t The more trades you have, the higher the probability you hit eventually exceptional uncertain numbers of losses/winners…

A better system is to lower risk with each consecutive loss, that would solve the problem of a string of losses. My opinion is, in general trading you should strive for, let’s say, much higher risk than 2%. If you’re winning then you can scale it up, losing then of course scale the risk down.

[PaladinFX]

The one that you’re displaying in this very post perhaps?

Being smart and well-versed in investment strategies is not a psychological element though, but rather the result of experience.

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You’re a prime example of someone who shouldn’t trade 25%, which is also fine.

I’m taking that as a compliment, meaning I treat trading as a business (which it is) rather than as a gambling adventure.

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I hope many people trade with a 25% risk … provided they fund their accounts again regularly, after each consecutive wipe-out.
Your liquidity is highly welcome.

O.

[Buckscoder]

A better system is to lower risk with each consecutive loss, that would solve the problem of a string of losses. My opinion is, in general trading you should strive for, let’s say, much higher risk than 2%. If you’re winning then you can scale it up, losing then of course scale the risk down.

That’s a anti-martingale. I doubt it will help much if at all, because it won’t improve your edge nor your mm. What you save with smaller risk after a string of losses will be burned with the big losses after strings of winners.

While the market has a memory then there is also the fact that your trades have no memory related to each other. So, what you are doing with a anti martingale is more gambling, less trading. Instead of focusing improving mm on top of a bad edge I’d rather look for getting a better edge. Because if you have a proper edge you need no fancy mm tricks.

Regarding the amount of risk - may everybody use what he want. Tho, I’d not go beyond a digit on each trade. That’s with a bot and not by hand. By hand I’d not go beyond 2%. Because I’m not a harakiri trader.

[SimonTemplar]

Elegant yet lethal, Mr Bond.

Well you can’t really argue with the maths. But its fine if you don’t feel comfortable trading that amount. Take note though that its no different you saying risking 25% is no good than me saying risking 2% is no good. Anyway I’m just going by the maths. The risking 2% option only works because its ‘not much’ so therefore when you lose, it won’t be much. Maybe not trading at all is the ultimate amount?

I wasn’t arguing with the maths, I was arguing that for me it would not be a sensible real-world route to follow, as I just don’t like big drawdowns on my account, and like my trading reliable, steady and consistently profitable.

I realize that you are joking about not trading at all being better - we’re both here on a trading website, so I guess that we both want to trade - but I am fortunate in being full time at this, so have a larger account than many on here, so risking 1% and making a double-digit return pcm on that gets me where I want my trading to get me. I realize that if I don’t agree with your approach then that is the same as you disagreeing with mine (I think that that is was you are saying), but I think I agree with you. Obviously I risk 1% because that means that a string of losses does not set the account back too much in percentage terms. I know that it is possible that I could have, say, three consecutive losing months. It has never happened, but I want a system in place that means that I could handle that, both practically and psychologically. So I never have more than four trades open (with exposed Stops) at one time and I never risk more than 1% per trade. Obviously I have those rules in place as I don’t like large drawdowns; they bother you less, so you risk more per trade. As long as we’re both happy with our approaches, we’re both right. Even if I think you’re a little mad and you think I’m a little safety-first!

What I see on this site pretty regularly, though - and I am [I]not[/I] saying that you are in this position, but this has prompted my participation in this thread - is newer traders upping their risk per trade in order to earn a better income from a smaller account. If an account is $500 then risking $125 per trade is easier, generally, than that same level of relative risk on a $500,000 account. I started trading, with a £2,000 account, with the same rules in place that I use now on a much larger account. There is nothing wrong with risking more per trade as long as the reasons for doing that are sound. For me, if a trader is taking on a large risk per trade because they want to accelerate their earnings, then that is a mistake, as that decision has not been taken for trading reasons. However, if there is a consistent strategy in place that makes a good return and works for larger accounts then that is quite different, imho.

Anyway, this is at risk of becoming circular but that’s what I think.

ST

[vladul11]

Hey guys.

Correct me if i am wrong but day trading with 25% risk is impossible with a leverage lower than 300-500:1, since with 20pip SL the margin required is more than 100% of equity. And as i found out by researching, most brokers lower the maximum leverage you can use as your balance gets higher. Is there a way around this?

Thanks.

Edit: Btw, if there is a way around this i will make a thread where i live trade with 25% risk and we’ll see where that takes me.

Anyone ?

[PaladinFX]

Correct me if i am wrong but day trading with 25% risk is impossible with a leverage lower than 300-500:1, since with 20pip SL the margin required is more than 100% of equity.

I don’t really see any difference between day and swing trading, in respect of the amount risked on a trade or the applied leverage.
You’ll just have to adjust your position size accordingly (i.e. decrease it), if you don’t want to find yourself with a stop-loss of 2 pips, which might get hit before you even lean back to watch your trade develop.
In general, day trading allows larger position sizes, since the expected swings are smaller; therefore, swing trading requires more capital than day trading, position traders need yet more.

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And as i found out by researching, most brokers lower the maximum leverage you can use as your balance gets higher. Is there a way around this?

Brokers decrease the permitted maximum leverage with growing account balance to stay within their own risk criteria.
The only way around that would be to split your trading capital, spreading it over various accounts which you’ll then control simultaneously by trading, for instance, with MT4’s MultiTerminal Platform.
Not every broker offers this though.

Many brokers however will negotiate custom leverage, so you might just ask your broker for an arrangement. Probably he’ll want a certain monthly minimum trade volume in return.

Cheers,
O.

[vladul11]

Thanks Oliver!

I don’t really see any difference between day and swing trading, in respect of the amount risked on a trade or the applied leverage.

There is a difference if you plan to risk 25%. A SL of 20 pips means more/bigger lots traded than a 100 pip SL. While the lot traded for the second may result in an appropriate margin level, the first one doesn’t. That is what i meant.

Eg: 1000$ balance.
100:1 maximum leverage.
25% risk = 250$.
Instrument: EURUSD

  1) SL = 100 pips => 2.5$/pip  => 2.5 mini lots size => (250 * exchange_rafe )$ required as margin => Possible
  2) SL = 20 pips => 12.5$ /pip => 1.25 standard lot sizes => (1250*exchange_rate )$ margin required => NOT possible

  And with 500:1 leverage the second case IS possible.

[dapperdan51]

Correct me if i am wrong but day trading with 25% risk is impossible with a leverage lower than 300-500:1, since with 20pip SL the margin required is more than 100% of equity.

I guess this would depend on your broker’s margin requirements, but assuming leverage of 100:1, then you’re quite correct …trading with 25% risk and a 20 pip SL would require margin greater than your account equity, although you would only need leverage of 125:1 for required margin to equal the balance in your account. A 20 pip SL does seem a little on the low side though, although I’m quite open to being corrected if there are market conditions or other circumstances where this would be acceptable (perhaps that’s for another thread?).

You could increase your SL and reduce the margin requirement by virtue of the fact that you are reducing your position size, but I assume that’s not the object of this (virtual) exercise!

It’s even more difficult for traders using US brokers (always assuming they would want to risk 25% of their account anyway) where the max. leverage is now 50:1 and the margin requirements are greater.

*** Apologies, I didn’t read the latest posts before submitting this, I realise you have gone over most of this already ***

[PaladinFX]

Thanks Oliver!

There is a difference if you plan to risk 25%. A SL of 20 pips means more/bigger lots traded than a 100 pip SL. While the lot traded for the second may result in an appropriate margin level, the first one doesn’t. That is what i meant.

Eg: 1000$ balance.
100:1 maximum leverage.
25% risk = 250$.
Instrument: EURUSD

  1) SL = 100 pips => 2.5$/pip  => 2.5 mini lots size => (250 * exchange_rafe )$ required as margin => Possible
  2) SL = 20 pips => 12.5$ /pip => 1.25 standard lot sizes => (1250*exchange_rate )$ margin required => NOT possible

  And with 500:1 leverage the second case IS possible.

Yes, of course … that’s why I said you’ll need to adjust (i.e. decrease) position size.
Position size should be chosen according to S/L, never the other way round.

The second case’s calculation should be 2500*exchange rate, not 1250 … which makes it even worse.

And a leverage of 1:500 I don’t even want to think about, hehe (shiver).

[vladul11]

The second case’s calculation should be 2500*exchange rate, not 1250 … which makes it even worse.

And a leverage of 1:500 I don’t even want to think about, hehe (shiver).

I think its 1250 after all
And as for the second line in the quote, i really dont understand guys/gals with this mentality. What difference is it to me if i have 500:1 or 100:1 if i only risk x% / trade?? It only reflects in the margin locked in. Why get so scared ??? I REALLY dont understand it.