The 2% rule

[cashmoney69]

I was reading through "Come into my trading room" last night and Elder talks about the 2% rule.

This tells traders how large a position they can take on a trade. Example:

your account is 50,000

you buy XYZ at 20, your profit target is 26 and you set stops at 18.

How many shares should you buy?

According to this rule, you multiply .02 by 50,000 which is $ 1,000, the max risk you may take. If you buy at 20 with an 18 stop means you'll risk $ 2.00 a share.

Divide the 1,000 dollars by your risk of 2.00, gives you 500. So 500 shares is your maximum.

Do any of you use this rule?

Some people say this is too high and to use a 1% rule...

- nathan

 

[Fredrik_Trader]

Yes I do, but I use 1.5 % as maximum risk.

 

[jho]

Nathan - Considering you are just starting out I think you should be risking less than 1% ... Maybe something like 0.3-0.5% then work your way up as you feel comfortable. Remember, you want to stay in this game as long as possible.

 

[cashonly]

I'm not a fan of exit strategies like this.

What you are doing is basing your trading on your account, not the market. The market doesn't give a rat's ass about your account, so don't be surprised if you get shaken out of a position only to see it turn right around and go in your favor using this type of exit.

What you need to do is determine how much room you need to give a position based on that particular instrument's volatility, support/resistance points, timeframe you intend for the trade, etc. THEN, look at that percentage and see if it is within a tolerance for your account... if it's not, adjust your position size for that instrument so you can keep within your 2% (or whatever # you feel most comfortable with). If you can't or don't want to adjust your position size, then find another instrument (ie if trading stocks, trade a different company, if commodities, try a different one, etc.)

While it is important to have these type of rules, they should be based on what you're trading and it's characteristics, not what you have in your account.

Cash

 

[Fredrik_Trader]

Since the market ” doesn't give a rat's ass about my account”, I sure will.

I don’t let the size of my account determine the place of my stop, but I let the size of the stop compared with the size of my account determine the size of the position I will put on.

 

[nononsense]

2% rule? 1% rule? 1.5% rule? 0.3-0.5% rule? etc&, etc&, ....

Who makes those rules? Obviously losers not knowing what they are doing.

The decision of the amount of capital to be put at risk is 100% related to the strategy used. It cannot be separated from it. You are basically dealing with the "Risk of Ruin" question.
Applying a crazy 2% dogmatic rule to a crazy losing strategy will still drive you into bankruptcy. The pain will simply last longer.

 

[William Rennick]

Find something you like, take the 50 k and use full margin. 100k will buy 5000 shares, set your price at 20.25, stop loss at 19.75. If you hit you just made 1250 bucks, vice versa if you lose. There is very little risk here. To buy only 500 shares on a strat that you believe should be a winner is not good. Patton once said "We need to guard against being too conservative"

Rennick

 

[jho]

Quote from nononsense:

The pain will simply last longer.

I agree with you there but if he risks less per trade then he will lose a lot less money before realizing his strategy isn't working (That is, if he is smart enough to quit before blowing up).

 

[Guildenstern]

This idea could only make sense if one were using large amounts of money and trading a basket of individual stock picks or option picks or whatever. It does not make sense if one is trading $20k or trading indexes. My guess is his 2% rule is to eliminate unsystematic risk (is this the right word?). There is no unsystematic risk (?) in indexes. One could make bigger trades and still adhere to a money management plan.

Opinions?

 

[nononsense]

Quote from jho:

I agree with you there but if he risks less per trade then he will lose a lot less money before realizing his strategy isn't working (That is, if he is smart enough to quit before blowing up).

Granted, assuming that some people indeed learn from their experience.