Chapter 7: The 1% Rule

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One of the simplest lessons to ensure long term success, is to never risk more than 1% of your trading account on any one trade.

The confusion

The 1% rule means that you never lose more than 1% of your trading capital, by implementing proper stop loss and correct position sizing on each trade

Keys to understanding the 1% rule: Eliminates the risk of ruin

The key to proper risk management is adjusting your stop losses and position sizes based on the volatility of your trading vehicle, so that when you are wrong, the consequences are only 1% of your trading capital

Limit losses

The reality is that you will have 10 or more losing trades in a row, or one unexpected event that causes a large loss. by using the 1% rule, you will survive these difficult times.

Preserves your capital

The ·1 job of a new trader is not to trade aggressively, but to protect their capital so it can grow. Managing your risk by implementing the 1% rule is the quickest and easiest way to accomplish this

Only risking 1% per trade will limit your trading size and enable you to sidestep big losses.

1% rule in action

1% risk per trade is the beginning point for position sizing:

Figure out what is 1% of your current trading capital, and decide where your logical stop loss is for your trade; the price level where you will know that you were wrong after a loss of a key support, resistance level, or trend line.

Example: if you are trading a $100,000 account and an apple trade entry is the break of the 50 day moving average at $100, then the stop is a 5% drop below your entry. %4 is the distance of the risk. So if $1,000 is my 1% risk, and i am risking $5 a share, then $1,000 divided by $5 is 200 shares. This is my position size

The danger of ignoring the 1% rule, is that if you are risking 5% or 10% of your capital on any one trade, and you are risking a equal weighted 5%, if you lose 10 times in a row, you are down 50%. You will have to see a 100% increase just to get back to even.

Trading 1%

If you are risking only 1% of your capital on each individual trade, then each one should only be one of the next 100

Know your ratio

The 1% is the designation of how much trading capital you will have at risk, and your position size will be determined by the volatility and average trading range of your trading vehicle.

Don´t stray from 1%

It may be tempting to increase your rule to 2%, but this should be avoided. Many professionals risk only half a percent to limit drawdowns

Watch correlations.

If you have ten open trades and all ten go down at the same time, you will have a drawdown of 10% in one day. Limit your correlated open trades in order to reduce drawdowns. This is compliment to the 1% rule

What we learned

The 1% rule is one of the most misunderstood rules in trading, and leads to confusion for many new traders. to the uninitiated, this rule may seem too conservative. However, by limiting your losses to only 1% on any one trade, you preserve your trading capital, and even after a losing streak, you will live to trade again.