Chapter 1 - 1% rule

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What is risk management?
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In short, risk management is the process used to protect your account from losing more than what you are willing to lose (your risk appetite and risk tolerance). If managed properly, it will help you to become a CONSISTENT trader.

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Risk-per-trade (1% rule)
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A key aspect of risk management is to set a maximum amount of risk per trade. How much the risk is dependent on the individual as everyone has different risk appetite and tolerance.

While everyone has a different risk appetite and tolerance, most professional traders risk between 0.5% - 2% of their trading account size per one single trade. This means if your trading account size is $10,000 and your risk per trade is 1%, you can risk a maximum of $100 per trade ($10,000 * 1%).

Alternatively, if you have a large account (eg. $500,000) you may not want to risk 1% ($5,000) per trade. Instead, you might only want to risk $1,000 per trade. This is known as fixed-dollar-risk.

Or, you might not want to leave too much money on an exchange to avoid counterparty risk, but you still want to maintain the same fixed-dollar-risk. For example, you might only want to leave $1,000 on an exchange while keeping the same $100 risk per trade (although in percentage term, it’s now 10% risk per trade).

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What is the reason of adopting the 1% rule?
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Whenever you lose a trade you will need to make more money back percentage wise to break-even. Say, if you have $10,000 and after losing 50% you now only have $5,000. In order to recover the $5,000 lose you will need to make 100% gain to return to your initial balance of $10,000. (ie. 100% gain required to recover 50% loss). Below is an idea done by TradingView’s top author EXCAVO which shows the more you lose, the percentage gain required to recover the loses are significantly increased.
Account Recovery

For this reason, we want to protect our account from losing too much in unfavorable situations.

Statistically, it is highly likely to have a losing streak of 10 (out of 1000 trades) if your win rate is 50%. If you are risking more than 2% per trade, you will most likely incur a drawdown of 20% at the minimum. But by sticking to 1% risk per trade, the drawdown is only 10% which is not as difficult to recover comparing to a loss of 20%+.

Thus, the 1% rule is designed to avoid large losses on a single trade so you can stay in the game. Many novice traders stopped trading because their accounts got liquidated before they had the chance to learn what TA truly is and refine their TA skills.

These people need a reason to explain their losses (human psychology) to comfort themselves. Thus, they come to the conclusion that TA does not work, not knowing - they can only succeed if they can keep staying in the game.

Taiwan Bear