When deciding to enter a trade the most important decision is determining how much to risk on the trade. The 2% Rule represents the actual percentage of a trader’s capital that he or she is willing to risk on a single trade should it go against them. So a trader with \$100,000 capital will risk \$2,000 per trade.

The 2% Rule is a concept many traders use, however the exact percentage you choose will be determined by your own trading capital. Traders with \$100,000 or greater may use a 1 or 2% Rule, while those with smaller accounts may use a 3 or 4% Rule. Either way, the only way to be successful in the market is to reduce losses when they do occur.

The level of risk per trade, 1 or 2% of your trading capital is kept at a small amount to avoid a string of losses that could wipe out your entire trading capital. Losses are always going to occur, but limiting the losses and preserving your trading capital are vital for staying in the game.

Using the 2% Rule, with \$100,000 trading capital, it would take 50 straight losses to wipe out your entire trading capital. You might get a few trades wrong in a row, but you would have to be very unlucky to have 50 wrong trades in a row straight-up. On the other hand, if you risked 25% of your capital per trade, it would only take 4 wrong trades to wipe you out. Even successful traders will have 4 losing trades on occasions.

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An example of the 2% Rule: A trader with \$100,000 trading capital decides to buy stock XYZ. The trader decides that he wishes to risk 2% – or \$2000 – on the trade.

Now that he has determined how much he is risking, he will now need to work out the position size. He could buy \$20,000 worth of stock and have it fall 10% before getting out, or he could buy \$10,000 worth of stock and have it fall 20%. In each case, he is still only willing to risk \$2,000 on the trade.

Should XYZ fall and the position is closed out with a \$2,000 loss, the trader will still have \$98,000 of trading capital.

Remember to only trade sizes you are comfortable with – the 2% Rule does not allow for market gapping.

Harley Salt, Senior Sales Trader, IG Markets

Disclaimers: The views expressed in this article are those of Harley Salt, a representative of IG Markets and is not intended as general advice. This does not constitute a recommendation nor does it take into account your investment objectives, financial situation nor particular needs.