Never risk 2% on any trade, is a commonly accepted currency trading tip. You will often hear as sound investment wisdom but if you want to achieve really great gains in the Forex market forget it, the trading tip is nonsense. The logic behind it is flawed and will ensure you never make great profits on your trading account.
Let's look at the logic behind you should only risk 2% per trade and why should actually used varied bet size and risk more than 2% of your trading capital, when the trading conditions are right and the risk reward is in your favour. Let's first look at the accepted wisdom that you should only risk 2% on any trading position.
How Much Should Risk Per Trade?
Conventional Wisdom on Risking 2% of Equity
“Never risk more than 2% per trade. This is the most common - and yet also the most violated - rule in trading and goes a long way toward explaining why most traders lose money”( Boris Schlossberg Kathy Lien)
Wherever you look online you will see this as so called investment wisdom and not many people seem to question I once asked someone at a seminar, a while back listening to a computerized trader talk about risk management. who quoted the 2% rule “Why not 4%? I asked. The answer was because “its to risky he replied” so I continued:
“I can risk 2% on a trade and do 3 different trades and that's less risky than risking 6% on one trade?”
The seminar guy replied:
“It's to risky to risk on one trade but 3 different trades is fine because there uncorrelated and give you a better chance of winning diversification reduces risk – don't you know about modern portfolio theory? Anyway its commonly accepted investment wisdom ”
Well I did and that's another theory which is nonsense in my view but rather than interrupt the seminar to much, thought I had better not argue about it. The idea of 2% being a optimum level to risk on a trade has no sound logic behind it and neither does the idea of diversification maximising returns and reducing risk.
The optimal amount to risk per trade is governed by varying factors which range from – the size of the account you are trading, your trading strategy, how well your account is doing and finally, how confident you are in a trade. The so called experts, who believe the 2% rule and the idea that diversification must cut the risk of trading see Forex as scientific whereas it's not and varying bet size makes far more sense.
Don't get me wrong, sometimes I think you should restrict risk because for any trading system to succeed longer term, you must preserve equity but in terms of having a set 2% risk set as a ratio to of your account equity as a maximum risk per trade - doesn't reduce risk at all.
If you have a poor trading strategy, you will just lose money slower and if you are trend following big trends, on a small account you will have to risk more to get in and hold the trend so your trading signal is not stopped out quickly after placing it in the market.
New Forex traders get obsessed with the 2% rule and you get a guy trading a small 2,000 dollar account try to risk $20.00 a trade! He thinks he is managing risk but all he is doing is trading with a stop loss level which is simply not far enough away from entry and just small amounts of volatility, see the stop loss clipped out the market.
Varying Risk Per Trade On Forex Trading Signals
I am all for restricting risk but if you want to maximize Forex gains and minimize losses, you should learn what most of the pro traders do which is - to vary position size depending on how your account is performing.
It can actually be proved that any market which features different probabilities of outcome, that gains can be maximized by varying the bet or in currency markets the size of the position. All trading strategies will have an edge to make profits long term and if the trader knows what is edge is it will increase or decrease, at certain times and it's not being rash, to increase position size when the right conditions present themselves.
“The way to build superior returns is through capital preservation and home runs” (Stanley Druckenmiller)
One of the conclusions reached by Jack Shwager in his excellent book New Market Wizards was – what seperated out the really great traders from just good traders was, they used their judgement to decide to increase their position size on a trade – when the right trade set ups presented themselves. Sure, they use strict money management but when they calculate that their edge is heavily in their favour - they bet big.
Increasing bet size at times when the risk to reward heavily favours your edge sounds like common sense to me but not the academics who say it's to risky. The problem is they are basing there evidence, on a set strategy, with no edge and of course, we all know that strategies vary and so do skills of traders. The risk of any currency trade going wrong is always there but to get the big returns you need to exploit your edge.
Varying Bet Size
Personally, I think when your doing badly on your trading account you should reduce bet size and keep it small until the account has recovered but if you are winning and have earned equity then not only is it easier on the mind to load up the risk is earned capital rather than core equity. A trader who does this to stunning effect is trading legend Randy Mackay. Mackay changes his risk factor by as much as 100 to 1, decreasing the risk on his account when he does badly but ramping it up, in periods in which he trading well.
Should You Risk Just 2% per Trade in Forex? No
The 2% rule as you can gather is not one we think, has much relevance in trading any financial market and this includes currency markets. This currency trading tip is all about ignoring it and keeping these facts firmly in mind:
Top 3 Tips on Much to Risk Per Trade
1. You need to vary your risk per trade depending on your account size and how well you are doing on your account.
2. When you perceive your trading edge has increased, look to risk more but keep the point below in mind:
3. Your risk exposure, should be varied at different times and be increased if you are in a winning streak and reduced if you are I a losing streak.
Money Management and Risk in the Real World
The 2% rule is one for the mathematicians who are not traders and like proving points with statistics in a world were, account size doesn't matter and the concept of a trading edge is not considered. If you live in the real world, like all currency traders do, ignore the myth of the 2% rule and the idea it decreases risk and instead, take the advice in this article – the world's best traders vary bet size and you should consider this method and if you do, you will maximize your profits while reducing risk at the same time.
