Risk Management in 1 Lesson

This is a crucial time to remember the 1% rule in this current market environment or better yet stay in cash until a trend emerges.

The very first rule we live by is: Never risk more than 1% of total equity on any trade. -Larry Hite (Market Wizard)

I try very hard not to risk more than 1% of my portfolio on a single trade. –Bruce Kovnar, (Market Wizard)

One of the simple principles that a trader must follow to ensure his long term success is to never risk more than 1% of his trading account on any one trade. This does not mean trading with 1% of your account capital it means adjusting your stops and position sizes based on the volatility of  your stock,  currency, commodity, option, or future contract so that when you are wrong the consequences are the loss of 1% of your trading capital. This not only eliminates your risk of ruin for a string of losing trades but also lowers the volume of your emotions and stress hormones so that you can think and trade with a clear mind and not have your ego step into a losing trade and hold it due to huge losses that you are unable to take due to the perceived consequences of the loss.

If you do not understand the reality of having 10 to 20 losing trades in a row or one huge unexpected event that causes a huge loss then the odds are that you have not been trading long enough to experience a volatile market or an unexpected event that shakes a stock, commodity, or currency or an entire market. The #1 job of a trader is not to make money but to protect what they already have and your capital is protected best through risk management.

Your trade entries should be designed to be at a price level and a position size that if after you enter it retraces and you are down 1% of your trading capital then you should know at that point that you were wrong and need to exit.

The inverse of the 1% rule as a stop loss is that your win size should be unlimited tot he upside, you will let your winner run until it reverses through a trailing stop at a price level that shows you that you  should exit and lock in profits because the nearest term support level is lost or a trend may be reversing. Your losses should almost never be more than 1% of trading capital but your wins can be 2%, 5%, 10% or even bigger when you enter at the price sweet spot  and a trend takes off.

Small losses and big profits are the secret of winning traders.

Link to an excellent video that explains the 1% trading rule:

Click for video of the 1% rule