Profitable Trading - Part 2 of 5
May 6th, 2008 by Erv
Never risk more than 2% of your account equity on any one investment, trade, or recommendation.
Make this a “golden rule” for any trading you do on your own. The only exceptions to this would be long-term core positions where you are not using any kind of leverage or margin.
However, for short-term investing like day-trading or swing/position trading, you should never risk more than 2% of your account equity on any one trade.
Let’s look at some examples. Let’s say you have $100,000 to trade with. If you risk 10% of your equity on every trade and you experience 10 losers in a row, you’re wiped out. You are out of capital, and out of the game. Even if you lose nine in a row, you’ve lost 90% of your equity and you then have only one chance left to be right. In that case, just to make back all the losses and break even you have to hit one heck of a windfall profit on that 10th trade.
On the other hand, if you risk only 2% on each trade, you have five times as many opportunities to be right. You have 50 opportunities instead of 10. And with 50 opportunities, the probability of you being right on any one trade goes up dramatically as does the probability of a winner that will run to full profit potential, helping to not only wipe out any losses you incurred, but to also push your account firmly into positive territory.
So how do you control risk so consistently? Tune in at some randomly selected time in the future for “Profitable Trading - Part 3 of 5″.
