2% or not 2%
We should all know the 2% rule. Devised by Dr Alex Elder. Says capital risked per trade should be not more than 2% of your total account.
I have followed this rule and quoted it here and elsewhere. My own current trades are running at about 3% risk on average - I'm not a novice but still conservative and still trying to respect the rule. But we shouldn't give unquestioning faith to any rule in trading.
First off, this rule first appeared in print no less than 23 years ago in "Trading for a Living", by Dr Elder. His name started to become known in the late 80's. His trading obviously pre-dates the launch of his website in 1988. That passage of time on its own should qualify for this to be re-visited.
Dr Elder is a psychiatrist who trades. Nothing wrong with that, but he is bound to bring a psychological viewpoint to his writings. It's therefore very possible that the major benefits of following his teachings are protection from negative psychological impact, rather than wealth generation.
Dr Elder's knowledge and experience in trading are derived from the US private trader's viewpoint. This is not necessarily going to be universally reflected by traders' conditions in other countries.
His experience pre-dates the huge increase in private trading in the late 1990's. I don't say good trading rules should have come out of the frenzied daytrading of the tech bubble, those were atypical market conditions, but some things in the game have changed since then.
His experience was (I think) derived from going long on US stocks in the late stages of a decades-long bull stock market and US economic expansion. As far as the markets were concerned then, I'm sure the feeling was this was never going to end. But being a long-only one-country share-buyer probably doesn't count as trading as we now understand it. How relevant is buying shares in a bull market to trading both ways on the huge variety of other instruments we can now access?
Sorry if I've taken a swing at your personal guru, but I suspect those of us who know the rule also break it every trade. Don't you?
I think his books are aimed at the novice trader and once you gain experience you'll do your own thing regardless of what any guru tells you in their 'new book'. He's just setting out a prescriptive money and risk management strategy for the neophyte and 2% isn't a bad starting point regardless of instrument or T/F IMHO
Interesting comments with which I empathise. The 2% rule is okay if you have a large amount of capital – in which case your 2% would probably be much less. The problem arises for the average starter trader who I suspect has considerably less capital. In this situation the only way to trade your way to substantially increased capital within a reasonable timescale, is to risk considerably more than 2%. So what should you do? My suggestion (and what I am currently doing as an experiment over and above my risk-conventional trading) is to find a trading methodology which has a high probability of success and use that in conjunction with stakes higher than the 2% rule.
I tried this in paper format over about 6 months to ensure the viability of the methodology and have just completed the 1st 5 weeks of trading for real. With 11 wins and 2 losers this has been considerably more successful than I expected with approximately 40% gain. Now of course, we are on a good trending upmarket on the S&P 500 and my situation may well be just a lucky snapshot, but I do believe nevertheless that because my basic methodology is simple (just find a good uptrending stock that appears to be stuck in an upwards rut and jump on board, and get out when you've got some profit) there may be some merit. Before I started I would have been pleased to make 10% per month which with compounding could soon turn your capital in to a respectable amount. E.G. you could turn ?1500 into almost 5000 in a year if you can make 10% per month.
Anyway, those are my thoughts and they reinforce my contention that a simple, basic and sound system is probably more important than all the fancy brain- hurting equations and systems that are sometimes purported to be the only way to profitability.
PS. I should add that one of the significant advantages of trading a small capital amount is that you can't actually lose very much (Guaranteed stops are very useful, and if as is sensible, you are only using money that you can afford to lose) there is little psychological pressure. E.G. Trading an SB of 0.24 points on the SP 500 might typically give you a loss of ?20-?30 at some stage of the trade; if you are trading higher stakes would you be psychologically able to handle a temporary loss of say ?400 without bottling out? Once the psychological pressures start building, things can change considerably.