How Much To Risk Per Trade? The 3% Rule
When starting out spread trading, I advise going small. I do not advise ‘paper trading’, as this gives an unrealistic experience of the emotional ride you will go through when you trade your own money! As in life, there is nothing like the actual experience of doing it for real. Paper trading is like fencing without a sword, and you can’t learn fencing from just a book. You need to experience the genuine emotions so that you can learn how you handle yourself in the market, and make adjustments, if necessary.
- For accounts smaller than £2,000: I would suggest no more than £2 per point on the Dow, the emini S&P, the FTSE, the Euro/Dollar. For Gold, which has ticks of $0.10 (so a $1 move equates to £10), I suggest £1 per point.
- For Accounts £2,000 – £5,000: I suggest no more than £3 per point for the indices above, and £2 for Gold.
- Accounts above £5,000: I suggest up to £4 per point for the indices, and £2/£3 for Gold.
These are good starting points for the first few months of trading. As you become more confident with your methods, you can adjust upwards, if you wish.
Keep the bet size as small as possible particularly if you are still starting out!
It makes sense if one is not yet consistently profitable to keep bet size as small as practical.
But please do not trade so big that you cannot sleep at night.
Trading should be fun, and for that, you need to be as stress-free as possible. I could get into recommending some exercises that have helped me to attain a balanced approach, but that may be for another day.
Money Management: Protect your Capital!
How Much To Risk Per Trade? The 3% Rule
Since trading is a game of probability, we must allow for a string of consecutive losses as a worst-case scenario, because being wiped out is a too-common fate for many traders. We must not go there!
To work out your bet sizing:
- Determine the maximum amount of your trading capital you are willing to put at risk per bet (generally up to 3%).
- Determine the entry trigger for your bet.
- Determine the stop loss level for your bet.
- Your bet size is (amount to risk in £’s)/(entry – stop-loss).
So, if you have £1,000 in your account, and willing to risk 2%, this equates to £20 amount to risk per trade. If the difference between my entry trigger and stop-loss is say 10 points, you should bet £2 per point.
I will tell you that I know of no-one who has had that amount of bad luck, so please consider that a real Black Swan event!
If you have a very small account, say £1,000, your maximum loss on one trade would be £30, which is unrealistic, given the volatility of today’s markets. That equates to a 30-point move at £1 per point in the FTSE or the Dow- far too close and almost guaranteed to stop you out.
So, for your small account, you need to up the risk level to 4% or 5% per trade, and take only 1 or 2 trades simultaneously. If you are very unlucky and have four losing trades, that would reduce your capital to 80% or so – but enough to stage a come-back of +25% to break-even.
But if your account, through bad management, reduces by 50%, you need to double the account to get to break-even – a herculean task. We definitely don’t want to go there!
I hope you can now see that we are treating trading as a business with contingency plans for a worst-case scenario. And we haven’t made a single trade yet! If you have made it this far, Congratulations! You may well have what it takes.
‘Risk management is the most important thing to be well understood. Undertrade, undertrade, undertrade is my second piece of advice. Whatever you think your position ought to be, cut it at least in half.’ – Bruce Kovner, founder and chairman of Claxton Associates, LLC
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