Do you know the one percent risk rule that will protect your account for you? If not, you should take the time to learn it. Trading doesn’t have to be as risky as people make it. In fact, there’s a lot of structure to stock market trading when it’s done the right way.
One Percent Risk Rule
Did you know that your position size, or trade size, is more important than your entry and exit points when day trading stocks?
Even if you have the best strategy on the planet, if your trade size is too big or too small, you’ll find yourself taking on either too much or too little risk. In any event, the former scenario is more of a concern; as risking too much will quickly evaporate your trading account.
In fact, most career day traders use a risk-management approach called the one percent risk rule or a slight variation of such.
Your Main Goal as a Trader
My main goal is to live to trade another day. Others well, they risk everything. And soon the trade goes in the wrong direction, and all their money is gone.
Does this sound familiar to you? What is one to do? How do you manage to live to trade another day? T
he rules are quite simple: Don’t risk more than one percent of your account size. You’ll see shortly; the one percent risk rule makes sense for many reasons.
Furthermore, you can and will benefit from understanding and implementing it as part of your trading strategy.
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Won’t the One Percent Risk Rule Limit Me?
Implementing and following the one percent risk rule means under no circumstances do you risk more than one percent of your account size on any single trade.
But, that doesn’t mean if you have a $30,000 trading account, you can only buy $300 worth of stock. You can use all of your account capital on one trade, or even more if you utilize leverage; which I warn against if you’re new.
Risking one percent or less with each trade doesn’t seem like a lot but, it can still provide excellent returns.
A rule of thumb to follow if you risk 1 percent, is to set your profit goal or expectation to 1.5 percent to 2 percent or more. To put it another way, a 1:2 risk to reward ratio.
Even if you win only half of your trades, by gaining a few percentage points on your account each day, your balance will grow. Take our courses to learn how to implement trading strategies.
A Surprising Fact
A fact often overlooked is that no one wins every trade, and that’s where the one percent risk rule comes in handy.
Think of it like this: By risking only 1 percent, you need to lose 100 trades in a row to wipe out your account. And if you happen to find yourself losing 100 trades in a row, it’s time to take a step back and reflect.
Personally, I recommend taking a step back if you’ve lost even five in a row. With this in mind, by following the one percent risk rule, you might have a chance of making it through your first year of trading.
Practice using the one percent risk rule with our stock watch lists.
Applying the One Percent Risk Rule
Risk is broken down into two parts; account risk and trade risk. The one percent risk rule works when implemented correctly.
Regardless of what the market conditions are, what the trade setup is, or what strategy you’re using, these elements fit together to give you the ideal position size.
Keep reading, and I’ll show you how.
Step 1: Calculate Your Money at Risk per Trade
Calculating your “money at risk” or account risk is the most crucial step to determine your day trading position size. You need to set a percentage or dollar risk limit you’ll risk on each trade.
For this example, you want to buy stock ABC, which is currently trading at $15, and your account is $30,000. In this case, your account risk is equal to 1 percent of $30,000, or $300. Which means you can risk up to $300 on each trade.
Similarly, if you risk 0.5% of your account, then you can risk $150 on the trade.
Whatever account risk you decide to take, keep it consistent. Don’t risk 5% on one trade, 3% on another than 1% on the rest.
For instance, if you choose 1% as your account risk limit per trade, then every trade you risk 1%. Hence the one percent risk rule.
Step 2: Calculate Your “Cents at Risk” on the Trade
Now that you know your risk limit per trade, it’s time to turn your attention to your “cents at risk” for the current trade. Your “cents at risk” is also known as your trade risk.
Trade risk is the difference between the stock buy price (your entry point), and your stop-loss price. Your stop loss, discussed below, closes the trade out at a specific dollar loss.
Any experienced trader will tell you; this is how to keep risk on each trade within your account risk limit. Each trade may be different based on volatility or strategy.
In some cases, a trade may have 5 cents of risk, while another trade may have 50 cents of risk. The one perfect risk rule is different for traders based on cents at risk.
Let’s circle back to our example of the $15.00 ABC stock. You can risk $300 on each trade. Then you take a quick glance at the chart, and you happen to see a trading opportunity.
You want to buy at $14.90 and place a stop-loss order at $14.89, one cent below, putting $0.11 at risk (cents at risk).
Step Three: Calculating the Share Size to Take
Now that you’ve identified your stop-loss, your next step in the one percent risk rule is to calculate how many shares to buy. Do you trade one share, ten shares, 100 shares or even 1,000?
Well, it depends on your account size and your 1% margin of risk. So, if you only have a small number of funds for day trading, then you have no choice but to trade in smaller share sizes.
The formula to calculate your ideal share size is equal to:
Money At-Risk / Cents At-Risk = Share Size
Divide $300 by $0.11 to get 2,727 shares; this is the maximum position size you can take on the trade. I suggest rounding this down to the nearest full lot (100 share increments), so you don’t expose your account to losses of more than 1 percent. In this case, your ideal position size for this trade is 2,700 shares.
You probably realized by now that 2,700 shares at $15 will cost you $40,500, $10,500 more than what you have in your account. To make this trade work, you’ll need the leverage of at least 2:1 in your account. But if you’re new, I strongly discourage trading on margin.
As a trader, you can plug any number into the formula to get your ideal share size. If you want to risk $300 on a trade and have $0.30 at risk, then your position size is 1000 shares ($300 / $0.30 = 1000 shares).
For simplification purposes, I did not include commission charges in my calculations above.
What Happens When the Price Moves?
If the stock price hits your stop-loss of $14.89, you’ll lose around $300, which is the 1 percent of your account.
However, if the price goes up and you sell at $15.22, you pocket around $600 (minus commissions). You make or lose 1 percent for each $0.11 price move.
Similarly, if you hold a bit longer and sell at $15.33, you make almost 3 percent on the trade, despite only a price move of 2 percent.
Wrapping up the One Percent Risk Rule
At the end of the day, it’s up to you what risk percentage you’re comfortable with taking. The one percent risk rule is just one risk management strategy you can use.
However, if you feel like 1% is a bit too much to risk, you can reduce the percent. I think it is better to risk-taking many small losses than to risk missing one substantial profit.
For me, I must live to trade another day. Thus with every single trade, I enter, I will protect 99% of my account; make it one of your unbreakable rules like it is mine.
With this in mind, before risking any money—even one percent—practice your strategy in a simulator to see if you can make consistent profits before putting real money on the line.
If you’re ready to start trading, the Bullish Bears stock trading service is here to help you every step of the way. We’ll make sure you don’t make the rookie mistakes of new traders. We want to see you succeed and live to trade another day. Be smart, be safe, and pay it forward!