What springs to mind when you think about a successful trader? Luck? Being in the right place at the right time? A lot of traders believe that success in this industry is about finding the perfect opportunity. But the real answer lies in consistency.
You’ve probably already figured out that in order to trade, you have to abide by certain sets of rules. The first rule of which is risk management. It’s certainly one of, if not the most important rule to follow. In order to earn money from trading, you have to learn how to manage your losses in the right way.
Risk management is the most important concept that all traders must understand and learn to apply effectively. It’s something that’s often overlooked and sometimes even completely dismissed, which can end up leading to bankruptcy.
When a trader treats a single trade like it will change his or her life, they behave like a gambler – something that is completely counterproductive. Trading is not gambling. If you find yourself thinking that trading is about luck, it can put you on a slippery slope. Risk management rules are there to help make your trading journey more productive.
The 2% rule
If you’re investing a random amount of money into a deal, you need to rethink your strategy. Allocating a carefully calculated amount can pay off in the long run. It’s widely accepted in the trading world that the optimal amount of money that you should invest in a single deal should never exceed 2% of your capital.
Learning how to control losses is one of the most important things a trader can do.
Regardless of the strategy a trader uses, they might still encounter a losing streak. In times like these, risk management rules are especially important. There is always a chance of failure.
It might be helpful to find a good balance between the potential profit and loss that you’re likely to incur. Some choose to settle for 2% of their trading capital per deal. So why is this? Well, according to them, 2% is a good figure for consistent trading and gives enough flexibility to survive any potential losing streak.
Let’s take a look at the example below. This details the comparison between 2% and 10% of the capital on a single deal.
| # of the deal | 2% | 10% |
| 0 | 10,000 | 10,000 |
| 1 | 9,800 | 9,000 |
| 2 | 9,604 | 8,100 |
| 3 | 9,411 | 7,290 |
| 4 | 9,223 | 6,561 |
| 5 | 9,039 | 5,904 |
As you can see, there is a massive difference between 2% and 10%. Simply by allocating 2% of the capital to a single deal, the losses might only reach 10% of the initial capital. But with a 10% stake in every deal, losses can be over 40% in a series of just 5 unsuccessful deals – it makes a huge difference. No matter how good you might be, it’s a good idea to keep humble and as disciplined as possible.
As a trader, you’re not looking to win the jackpot. Instead, your focus should be on a series of small wins, with each win getting you closer to your ultimate goal. Slow and steady wins the race!
