[David Waring]

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In our last lesson we looked at the difficulty of overcoming a loss in the market to further emphasize the importance of protecting your trading capital as a critical component of any successful trading strategy. In today’s lesson we are going to start to look at the first and one of the best ways of protecting one’s trading capital, setting your initial stop loss.

As we learned about in our lesson on the effects of trading losses, 50% or more of the trades made by many successful trading strategies are losers. These trading strategies and traders are successful not because they are highly accurate on a trade by trade basis, but because when they are wrong they cut their losses quickly and when they are right they let their profits run. While the trading strategy that you eventually end up trading for yourself may have a higher success rate than what I mention above, any strategy is going to have loosing trades, so the first key to staying in the game is to have a plan for managing those losses so they do not get out of control and wipe out your chances for success.

With this in mind, what most traders will start with when designing a plan for setting their initial stop loss is the amount they can afford to loose on a per trade basis without having a detrimental affect on their account. While this varies from trader to trader and from strategy to strategy, as Dr. Alexander Elder mentions in his book Trading for a Living, many studies have shown that trading strategies and traders who risk more than 2% of their overall trading capital on any one trade are rarely successful over the long term. From what I have seen most traders risk way more than this on an individual trade basis, another large contributor to the high failure rate among traders.

Traders who set their per trade risk level at 2% of their trading capital or less, not only put themselves in a situation where a fairly lengthy string of losses will not knock them out of the game, but also put themselves in a situation where any one trade is not going to make or break their account. This is important not only from a money management standpoint but also from a trading psychology standpoint in that they are not attached to any one trade and are therefore more likely to stick to their strategy.

In order to have a true understanding of what this number should be for a specific strategy you will need to know what the expected accuracy rate is for the strategy, something which will cover in later lessons. For now however it is sufficient to simply understand that you need to have a feel for how much you plan to risk on a per trade basis as a first step in designing a successful money management strategy, and that you should be very wary of any strategy which risks more than 2% of your trading capital on any one trade.

Now that we understand that determining how much to risk per trade is the first step in any successful money management strategy, we can move on to other methods of setting your initial stop which fit within the limit set by the amount a trader is willing to risk on a per trade basis.

As always if you have any questions or comments please leave them in the comments section below so we can all learn to trade together, and good luck with your trading!

[kawola17]

Hello Dave,

Thanks again for all your videos! This section is definitely the missing link in my trading strategy that I have been looking for.

Whenever I hear 2%, it sounds so little. But when you actually do the calculations, it's quite a lot.

For example an account of $20,000. 2% would equal $400.

That's $400 at risk for each trade, that's quite a lot in my opinion.

I totally agree with the 2% rule.

Thanks again.

Sincerely,
Bill

PS> Your previous video is a repeat of the one before.

[David Waring]

Hi Bill,

Yes I would say you are not alone there when you say that at first 2% sounded too small as I was in that boat too. What kind of made it all click for me is when I tied this into trading psychology and the ability to last over the long term. At 2% risk it is a lot easier to be emotionally detached from each trade which helps me make better decisions as I know that I can have a long string of losses before I am in danger of being knocked out of the game.

Thanks for the heads up on the other video, you can view the correct video there now.

Best Regards,
Dave

[daniel_asimov]

Hello David...

Money management for sure is the most important pillar of trading.
And unfortunately the most neglected.

Bill..
You where commenting an example for the 2% rule .


In my case... from the total amount of my account I calculate the 2% and break it down from there.
Example:

Account Value: 20,000
2% Risk: 400

Which I break down into pieces like this.
for every 10,000
risk: 200

and going deeper...
For every 1,000
risk: 20

It sounds very little when taking in consideration spread cost or/and fees.

What I use this for is to discipline myself on trading proportionally in
accordance to the size of the trade vs the size of the total account.

Won't make sense to risk 200 on a 1000 trade.. Even if 200 is 2% of the overall account, it's a BIG 20% in this single trade.

I might be wrong on these one... But it works for me so far.

Good trading.

[David Waring]

Hey Daniel,

Glad to hear from you and very well put. I am glad to see we have a growing community here of traders who understand the importance of money management, as in my opinion this raises the quality of the community substantially.

Best Regards,
Dave

[daniel_asimov]

Hello David..

I'm also very glad to see this community grow.. I do enjoy a lot to reading thru the comments of many traders.. And trying to catch up reading so much great material in here...

appreciate you have this space and thanks for sharing..

-Daniel

[derrickno]

HI Daniel...

I´m a newbie and found your post very interesting... I´d like to know how you calculate your risk for a $1000 trade. In my case, I have to pay a minimum comission of $15 for every movement (30 to buy and sell). So, even if I buy for $1000 and wanted to sell at a loss, I would have a loss of 30 minimum...

Good luck trading...

Originally Posted by daniel_asimov

Hello David...

Money management for sure is the most important pillar of trading.
And unfortunately the most neglected.

Bill..
You where commenting an example for the 2% rule .


In my case... from the total amount of my account I calculate the 2% and break it down from there.
Example:

Account Value: 20,000
2% Risk: 400

Which I break down into pieces like this.
for every 10,000
risk: 200

and going deeper...
For every 1,000
risk: 20

It sounds very little when taking in consideration spread cost or/and fees.

What I use this for is to discipline myself on trading proportionally in
accordance to the size of the trade vs the size of the total account.

Won't make sense to risk 200 on a 1000 trade.. Even if 200 is 2% of the overall account, it's a BIG 20% in this single trade.

I might be wrong on these one... But it works for me so far.

Good trading.