2% Rule - (Part 2 ) : The 2% Rule Can Explode Your Profits, But You Need To Follow this Warning

Jay's Market outlook for 23rd feb, 2007: European markets made moderate gains last night. The main US indices were mixed again, with the Dow down, and the NASDAQ making a modest gain. Asian markets are mixed this morning, with the Nikkei unchanged and the Hang Seng down quite heavily. On balance, the global short-term trend looks down. This may lead to a further fall here today.


2% Rule - Part 2 : The 2% Rule Can Explode Your Profits, But You Need To Follow this Warning

The 2% rule is a powerful tool in trading. By adopting this rule you're using a strategy that decreases the size of your losses during losing streaks, an important consideration. There is, however one small caveat that you need to be aware of when using the 2% rule to calculate how many shares you are going to buy. As you know, the number of shares you can purchase is determined by your maximum loss and the size of your stop.Which means that by increasing your risk, you can also increase the dollar value of the position you open.

Or, by simply shrinking your stop size, that is by setting a tighter stop loss, you can increase the dollar value of the position you open.To avoid a situation where you could end up with excessively large positions that may put your trading float at risk, you can choose to introduce an extra rule.This rule would limit the dollar value of a position to be no more than a set percentage of your entire trading float. For example, you might decide that you'll never open a position that has a dollar value of more than 25% of your entire trading float. This rule would only be executed if, after calculating the formula that determines how many shares you buy, you find the dollar value of that position would greater than 25% of your float.

If this happened, you would scale down the position to make sure it did not exceed that 25%.The percentage that you decide upon will depend on the type of system you're trading, the size of your float, and your personal tolerance for risk. Generally, smaller trading floats might use 25%, and larger trading floats might use as little as 10% or even 5%.There are no definitive numbers, and the percentage that you choose will depend on your personal circumstances.Once this tendency is corrected for you will have all your money management rules in place, ready to control your risk.

Now you need to take the next step. Test your system to find out which of the variables best suit you, remembering always that position sizing is the most significant part of any system design.It is the lynch-pin of money management. Once you've tested your system, and fine-tuned your rules, you will be well on your way to becoming a successful trader.

ABout Author : This article has been extracted from David Jenyns' Trading Secrets Revealed Course. David Jenyns is acknowledged as a leading expert ondesigning lucrative trading systems.

2% Rule (Part 1) - Professional Traders Never Risk More Than 2%

Jay's Market outlook for 22nd feb, 2006 : European markets faced a moderate to heavy decline last night. The main US indices were mixed, with the Dow down, and the NASDAQ making a modest gain. However, Asian markets are up this morning, and the global short-term trend appears to have turned up again after something of a reaction yesterday. This could help our market to stage a rally today


Professional Traders Never Risk More Than 2%

Studies have shown that you should never risk more than 2% of your float on any trade. Why 2%? Well, in fact, many professional traders will tell you that 2% is too much. They'll risk 1% or even as little as a quarter of a percent on any trade. Whatever percentage you pick, the idea is to ensure that no one trade is really going to affect your trading float, positively or negatively. Many traders don't appreciate how powerful this rule is.


By simply changing the amount of capital you risk, you can turn a system from returning 10% to returning a 100% per annum. Now, by increasing risk, and investing more in a trade, you do increase your chance for reward. However, you also end up increasing your draw down as well. You may want to do a bit of testing to fully understand the importance and the power of changing this one variable. I always recommend that you never exceed a 2% risk, but it can be a difficult to understand the difference that keeping your losses small can make to your trading.



Let's look at an example of the 2% rule in action. If we had a trading float that was $20,000, using the 2% rule we set our maximum loss to be $400 on any one trade. With this maximum loss, we could have a string of 50 losses in a row before we had no more capital left to trade with. In most trading systems the chances of getting 50 losses in a row is very, very slim. However, the chances of going broke are even smaller, because when you implement the 2% rule correctly, the calculation is based on the current float size.


So, initially 2% of $20,000 is $400. However, if we experienced a loss first off, our trading float would now be worth 19,600 dollars. We then calculate 2% of this new value, and set our maximum loss for our next position. 2% of $19,600 dollars would be $392. You can see that each time we experience a loss, our next maximum loss would shrink. As our portfolio increases in size, we're happy to take on more risk as well.I thought I'd play around with a few of the figures just to see what would happen if we had a string of six losses in a row. After receiving six losses in a row, our trading float would have decreased to only $17,717.


After six successive losses, we've only lost $2,283. Now, that's managing your risk.The fact that the loss is such a small component of our trading float makes it much easier to gain back those losses. In this example, we've lost a little bit more than 10%. To gain back that loss and break even, we'll need to make 11.1%. Now, imagine if we didn't have good money management in place and we had a draw down of over 50%. If we have a draw down of 50% and we loose it, we need to make 100% return on our remaining capital to break even. You can begin to see the how a larger draw down makes it more difficult to recover from losses. Novices often risk more than 2%. Even if you're starting out with a small trading float, you should practice good money management. You need to position yourself so that you can endure long strings of losses, and maintain your trading system. When the market does turn around, you'll be in the market positioned to capitalize on it's moves.



That's what setting the maximum loss is all about, it keeps you in the market, allowing to you to keep your trading system going. If you can survive while some losses while trading, the profits will come.



ABout Author : This article has been extracted from David Jenyns' Trading Secrets Revealed Course. David Jenyns is acknowledged as a leading expert ondesigning lucrative trading systems.