Trading can be a useful way to earn big on global markets, but these big rewards also come with big risks. Money and risk management techniques are an essential part of trading to ensure these risks don’t translate to massive losses, and the 1 percent risk rule is a useful risk management method to help minimise loss and protect you from harsh market conditions. Here’s everything you need to know about the 1 percent risk rule, and how you can add it to your trading repertoire.
What is the 1 Percent Risk Rule?
Put simply, the 1 percent risk rule is making sure you never risk more than 1% of your account value on a single trade. For example, if you have $50,000 in your trading account, you should only risk $500 in any given trade.
Why you should use the 1 Percent Risk Rule
The 1 percent risk rule is an easy way to insulate your income from risky trades or volatile markets- by only risking a maximum of 1% on a single trade, you would need to lose 100 trades in a row to fully wipe out your account. Since this is very unlikely to happen unless something is very wrong with your trading methods, using the 1 percent risk rule helps you withstand your losses.
Risking 1% might seem like a small amount to invest, but remember that even small trades have the potential to earn you a lot of money if you predict market movements correctly. Restricting your trading to a maximum risk of 1% means you enjoy any potential big wins without having to worry about becoming destitute on a big loss.
How to use the 1 Percent Risk Rule
There are two ways to deploy the 1 percent risk rule. The first method is simply keeping your account value in mind and making sure you don’t risk more than 1% of that value on a single trade. The second method involves setting up a stop-loss on your trades so your losses do not exceed 1% of your account value, while giving yourself the potential to earn more through employing leverage. This latter option gives you wiggle room to invest more in a single trade without breaking the 1 percent risk rule and inviting larger losses than you can handle.
A stop-loss is a type of stop order, an instruction to trade when the market hits a level less favourable than the current price. Stop-losses are useful ways to restrict your losses, enabling you to pull the plug on a position that is costing you money. You can find out more about setting up a stop-loss, as well as other money management tips to help maximise profit and minimise loss, here.
To use stop-losses in conjunction with the 1 percent risk rule, you first calculate how much of your account value you can risk, which is to say, 1% of your account value. Then, you calculate your trade risk, which is the difference between your stock buy price and your stop loss price. Divide your account risk by your trade risk, which gives you the proper position size, which represents how many shares you can buy in a given trade without exposing yourself to losses greater than 1% of your account value.
While stop-losses help you minimise losses from a trade, leverage enables you to gain a large exposure to a financial asset using only a small amount of your trading capital. You can use the proper position size of a given trade to calculate how much leverage you need to make a trade and maximise your profit, while staying within the boundaries of the 1% risk rule.
When you buy an asset in the traditional way, you generally need to pay the full purchase price up front: the total value of the shares, currency, barrels of oil or whatever you’re trading. However, some providers offer the facility to trade using leverage, which means you only have to put up a fraction of the value of your position. Effectively, your provider lends you the rest of the purchase price. This allows you to essentially invest more than 1% in a trade without breaking the 1% risk rule.
By using leverage alongside stop-losses, a skilled trader can maximise their profit and protect themselves from significant losses while still protecting their finances with the 1 percent risk rule.