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The 1% Risk Rule
There are many ways to minimize risks and losses when trading. One of them is the 1% risk rule.
What is this 1% and why should every trader know it? What is the benefit of the rule?
Well, we will take on this task and tell you what the 1% rule is and how it can be useful for you.
What is the 1% Risk Rule?
The 1% method of trading is a very popular way to protect your investment against major losses. It is a method of trading where the trader never risks more than 1% of his investment capital. The main motive behind this rule is in terms of protection – you are not risking anything other than what is available.
Why using the 1% Rule can help you succeed?
The 1% rule is a great way to keep traders afloat without big losses. For beginner tradersor experienced traders, this strategy will help you play it safe and reduce your risk of losing funds in any given trade by limiting how much money goes into each bet.
When should the 1% rule be used?
Even the most experienced trader is unable to manage anything but risks.
Trading is not gambling. As a trader, your goal is to control risk and stay in the game. If you want double counts on every trade, you are better off playing cards at a blackjack table or slot machines near Las Vegas.
One unsuccessful trade can destroy the entire trading account mostly when you are a beginner. There are 2 outcomes in a situation like this, either you make an emotional decision or never open positions again.
The 1% rule can be used to avoid chafing and double down on your profits instead.
How does the 1% Risk Rule work? Example
Let’s look at the 1% risk rule with the example:
Let’s say you have $60,000 to invest. Buying an asset for $300 does not mean that you can only buy 2 of them (60.000*0.01 = 600, 600/300=2).
Agreeing with the rule you just have to close your position if the loss exceeds 1% (in our case it is $300). All you have to do in this case is to understand where to place the stop-loss order.
Set Stop-Losses Orders
When you trade, your stop losses must be set at a level where they will protect against any potential killing moves. A stop loss is an order that closes a trade as soon as the price reaches a predetermined level. Usually, they are placed at the maximum amount of money you risk.
Stop-loss is a great tool to manage risks, especially in Forex trading. You can find a list of guaranteed stop loss brokers here.
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types of stop-loss orders
There are 4 types of stop-loss orders. Let’s get acquainted with each:
Percentage stops
The percentage stop-loss will help you to avoid losing more than your initial investment. This means that if, for example, a trader wants to risk 1%, they could place an order at such levels so as not to allow losses to exceed this percentage of their total trading account balance – in other words, it’s designed specifically with smaller positions in mind.
Chart stops
Chart stops are a great way to ensure your trades do not go against you if the markets start heading in another direction. They can be placed above or below important levels that might change based on what is happening with other assets during specific points of time, such as Fibonacci ratios and Pivot Points – which some traders even use for protection within their trading plan- but it all comes down to how they are set up.
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Volatility stops
Another type of stop-loss that traders may use is the volatility one. This type depends on how volatile an instrument’s price has been recently and can be based on popular indicators like ATR (Average True Range). For example, you could place a 1/2 times higher limit than what would otherwise recommend for your typical trade if it was going to move more than expected; however, this will only work when taking positions quite large in size – smaller trades should always respect whatever ATR position setting comes first.
Time stops
These orders will only be activated during specific times of day, so you can avoid overnight losses or holding trades over weekends without having any effect on how much profit is made.
Exceptions from the 1% Rule
The one percent rule can be difficult to follow when trading in illiquid markets. For example, if you are trying to trade $10K worth of an Oil futures contract and the spot price remains at 50 dollars per barrel for ten consecutive days without any buying or selling activity – it will take more than just 1%. As such orders, less than 10% may not work due to their low liquidity factor which results from low market capitalizations (high trading volume).
1% Risk Rule Conclusion
One of the biggest mistakes new investors make is that they bet big and lose everything in the blink of an eye. To combat this, traders use the 1% rule. It helps to limit the kills by minimizing the risks.
The 1% rule is somewhat similar to the Negative Balance Protection feature in Forex trading, where a trader’s account is locked out when capital falls below $0. Find more about Negative Balance Protection Forex Brokers here.
In summary, we would like to say that this rule is very important in terms of managing risks and profitable deals.
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The 1% Risk Rule is a cornerstone in risk management for traders, aiming to safeguard investments by limiting potential losses. It's a practice where traders never risk more than 1% of their capital on any single trade. This rule acts as a shield, preserving a substantial portion of your investment from significant downturns.
Implementing the 1% rule is crucial for both novice and seasoned traders. For beginners, it prevents emotional decision-making after a substantial loss, ensuring they stay in the game. For experienced traders, it serves as a fundamental strategy to maintain control over risk and stay afloat.
To execute this rule, setting stop-loss orders becomes pivotal. Stop-loss orders are mechanisms that automatically close trades when prices hit predetermined levels, effectively capping potential losses. These orders come in various types:
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Percentage Stops: These limit losses to a predetermined percentage of the total trading account balance, ensuring you don't exceed a set risk threshold.
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Chart Stops: Placed above or below crucial market levels, like Fibonacci ratios or Pivot Points, chart stops prevent trades from going against anticipated market movements.
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Volatility Stops: Depend on an instrument's recent price volatility, employing indicators like ATR (Average True Range) to set stop-loss limits. They adjust based on market movements.
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Time Stops: Activated during specific times of the day, time stops prevent overnight or weekend losses by closing trades before these periods.
However, there are exceptions to the 1% Rule, particularly in illiquid markets. In such cases, where market liquidity is low, adhering strictly to the 1% rule might not be feasible due to the market's low trading volume.
Ultimately, the 1% Risk Rule serves as a shield against catastrophic losses. It's akin to the Negative Balance Protection feature in Forex trading, preventing accounts from falling below zero. This rule is a key aspect of risk management, enabling traders to navigate markets with a higher probability of preserving capital and making profitable deals.
The provided article covers:
- Explanation and significance of the 1% Risk Rule
- Application scenarios for the rule
- Strategies for implementing stop-loss orders
- Types of stop-loss orders: Percentage, Chart, Volatility, Time Stops
- Exceptions to the 1% Rule in illiquid markets
- Importance of risk management and its relation to profitable trading
The article also extends resources like trading plans, broker recommendations, and emphasizes the importance of managing risks for sustained success in trading.
