# Amount to Risk per Trade / 2% rule

## Q. How much should I risk?

A: Most traders simply pick a number out of thin air or choose the same amount on every trade they place but this is a blunder. Trading the same amount on every trade means that the absolute risk on each trade will fluctuate wildly. Your stake on any one trade should be determined by your account size, the perceived risk and the proportion of your account you are ready to risk.

I found this simple formula useful to control risks. I recommend that your daily profit target is no more than 2% of your capital, your initial risk on a trade is no more than 4% of capital and your stake size is 2% of your capital. For example, if your capital is £10,000, then your initial stake size is £20 per point, your risk is £400 (maximum stop loss is 20 points) and your daily target is £200. Clearly, if you were to start with a higher capital balance you can increase your stake size based upon a similar calculation. You should risk no more than 4% on each trade as I believe a cautious approach is best and will give you the leeway and cushion to weather the inevitable losing trades.

When the trade has moved 10 points in your favour I move the stop loss level to lock in your profits.

Usually if the trade is going to achieve a 20 point profit it does so reasonably quickly. Your first trade is generated usually within the first hour of trading. So a successful trade (i.e. 20 point profit) is completed by say 11am. In such circumstances you will earn 3% on your capital. The following example illustrates:

BUY £20 @ MARKET PRICE (4500) & PLACE STOP TO SELL £20 @ 4480 8:24AM.

MOVE STOP TO SELL £20 FROM 4480 to 4510.

LONG TRADE CLOSED @ 4520. PROFIT TARGET ACHIEVED. CANCEL STOP.

The profits earned would be £20 X 20 = £400. This is 4% of your capital. Remember our target is 2% overall, so you will need some days above average earnings to compensate for days when you lose in order to average 2%.

Note: Malcolm Pryor points out that position sizing (or bet size) has to be matched to risk preferences and objectives. For long term success there are several commonly referred to benchmarks. In the Market Wizards books by Schwager betting as much as 3% per trade is referred to as gun slinging, and most of the Market Wizards mention 1%, or even less, as being the most they are prepared to bet on any one trading idea. The reason for this is that even if you have a strategy which wins in the long run say 55 out of 100 trades you are still likely to get a run of 7 or 8 losers in a row once in a while. If you are risking say 5% per trade that will cause a big drawdown which can be difficult to recover from.

## Q. Can you explain how you go about figuring out what amount of shares you should buy, or amount you should spend on a holding to be in keeping with the 2% rule?

I only have a small amount to play with (£2000) and am trying to build up, my holdings will result in about a 3% loss of the overall portfolio if they lose 10%. If I bought more holdings at a lower cost then it would not be worth it at the moment as commissions etc would eat me alive...

A: It is suggested that you don't want to lose more than 1% of your pot on any share as risk management. So if you apply a 10% stop loss, 10% of your pot could be in one share because 10% of 10% is 1%. If you applied a tighter stop, it could be more of your pot, a looser stop it would be less. It would mean that if you applied the 10% stop right across your pot, you would have 10 stocks in your pot as a minimum. What you have to accept is the fewer stock you trade, the more volatility you get. There are many who pile in to just a handful of stocks, but I like to sleep at night :)

If I have a pot of £10,000 for example I could afford to lose no more than £200 based on the 2% rule (some say 1% or less but that's something else).

I decide to buy share A at 100. Stop 90. Max loss 10 points.

£200/10 = £20 per point = 2000 shares. [to calculate the equivalent share value you need to add 2 zeros to your stake]

You could argue slightly less to take account of dealing costs.

If you set a tighter stop at 95: £200/5 = £40 per point = 4000 shares.

In your situation a pot of £2000 gives you a max loss per trade at just £40 using the 2% rule and which would make these money management rules very difficult to apply. I think that if your account is small you'd have to relax those risk parameters a little to be viable otherwise you will be stopped out by the smallest movements in price. Of course doing this increases the chance of blowing up. When I say a bit though I mean a bit not a lot. I think if you are using 2% you could open it up to 4%-5%. On the other hand there is nothing wrong wth taking it slow and safe. Compounded returns do a lot to an account. The first couple years might seem like a waste but then one day you will look at your account and realize how big it actually has grown. Of course every extra penny that you can add to your account would be helpful.

The theoretical formula is provided below

No of shares = N
Sum you are prepared to Risk losing in pence = R
Purchase price of share - stop price of share + spread value = P
Then N = R/P

Example PZ Cussons (PZC) :

Sell price = 381p
Stop at 10% below buy price = 354p
You may want to lose a maximum of £20 = 1% of your capital = 2000p

N = 2000 divided by (384 - 354) + 3 = 200/33 = 60 shares

Edit: that excludes brokers fees as I got figures from spreadbet platform.

## Q. How do I determine my risk level?

A: Perception and risk mean different things to different people. For instance someone who earns £1 million a year will not think much of losing £1500 but for the person who earns £15,000 a year, losing £1500 could be seen as catastrophic. The key is to consider money as simply a tool to make you more money and for this reason we must detach our emotions from money. This is where risk management and stop loss orders come into play.

Risk management is critical to succeeding in spread betting. Risk management is the part of trading that dictates how much of your capital per trade you will risk and in general this shouldn't exceed 2% of your pot.

Assuming you have chosen a trade and have already determined your entry and stop loss level you can work out the price per point as follows:

Suppose you have a £10,000 trading account, setting the risk level at 2% would amount to a risk amount per trade of £200.

If you buy a spread bet (go long) at 240 with the stop loss at 200 this equates to a 40 point difference. So dividing the risk amount (£200) by 40 returns the amount you should be per point (£5) to maintain this risk level.

Position Size = Account Risk / Trade Risk.

Position Size = (1% x account value) / (entry price - stop loss).

It is crucial that you do not change the risk level during open trades - risk management will instantly give you an advantage over the majority of beginners who just randomly pick amounts to trade, it will protect your pot and keep you in the game longer.