The one-percent rule
A common upper limit is to risk at most one percent of your account per position. That way you survive even a long run of failures and can keep going.
Learning objective: After this lesson you can apply the one percent rule to a position of your own.
If Mia has €5,000 in her account, one percent means a single failure may cost her €50 at most. It's the loss that's limited, not the position. So she can certainly buy €1,000 worth of shares if her stop is placed so that she loses €50 in the worst case.
That sounds like very little, and that's the point. Ten failures in a row then cost her just under ten percent. That hurts, but she can carry on. With ten percent risk per trade, the same ten failures would wipe out about two thirds of the account.
Runs like that are normal. Even someone who's right six times out of ten regularly goes through five or six failures in a row. That's not a losing streak, it's statistics.
The rule applies to active trading with individual positions. You don't need it for a broadly diversified savings plan, because no single security there can seriously hurt you.
Losing runs are more likely than it feels. With a win rate of 55 percent, the chance that exactly the next six trades all lose is 0.45 to the power of 6, so under one percent. Over a hundred trades, though, it's still likely that such a run turns up somewhere, because there are so many points where it can start.
You can think of the rule as a simplified version of a calculation that determines the stake at which an account grows fastest. That calculation is called the Kelly criterion. It needs win rate and payoff ratio as inputs. Because both are only estimated in practice, and usually overestimated, careful traders only use a fraction of the Kelly value. That lands you roughly at the one percent rule.
Correlation matters. Five open positions with one percent risk each are only five separate risks if they move independently. If you buy five chip stocks, they often all fall together on bad news for the sector. Then you're really risking almost five percent at once. So the rule should be applied to the whole portfolio, not just to each position separately.
Summary
- One percent limits the loss, not the size of the position.
- Six failures in a row are normal.
- Positions that move together add up their risk almost completely.
Did you get it?
What exactly does the one percent rule limit?
The maximum loss of a position, not the money put in.
Why use only a fraction of the Kelly stake?
Because win rate and payoff ratio are only estimated and usually overestimated.
Why isn't the rule per position enough?
Because related positions move at the same time and their risk almost adds up.
What others often ask about this
What percentage should I risk per trade?
Many experienced traders stay between 0.5 and 2 percent. For beginners the lower end makes sense, because the hit rate is usually lower at first than expected.
Does that apply to a small account too?
Yes. With €1,000, 1 percent is only €10, but that's exactly how you learn without risking the account.
Check your understanding
Sources and further reading
- The Kelly criterion traces back to John L. Kelly's original 1956 paper in the Bell System Technical Journal, which derives the growth-optimal bet fraction for repeated wagers with a known winning probability. View source ↗
Related
- Calculating position sizeStage 3
- Risk-reward ratioStage 3
- Win rate and expected valueStage 3
- Matching questions for this stageQuestions