1% Risk Rule

By:

James Knight

James is the Editor of Education for Invezz, where he covers topics from across the financial world, from the stock market, to cryptocurrency, to macroeconomic markets.... read more.

Reviewed by:

Idil Woodall

... read more.

Updated:  May 23, 2024

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3 min read

3 key takeaways

• The 1% risk rule helps traders manage risk by limiting losses to 1% of their total capital per trade.
• It promotes disciplined trading and helps protect against significant losses.
• This rule is widely used in both stock and forex trading.

What is the 1% risk rule?

The 1% risk rule is a fundamental risk management strategy used by traders to limit potential losses. According to this rule, a trader should never risk more than 1% of their total trading capital on a single trade. This helps in managing risk and preserving capital over the long term.

By following the 1% risk rule, traders ensure that a series of losing trades will not significantly deplete their trading account. This approach promotes disciplined trading and helps to avoid emotional decision-making, which can often lead to substantial losses.

How the 1% risk rule works

To apply the 1% risk rule, traders first determine their total trading capital. Then, they calculate 1% of this amount to find the maximum risk they are willing to take on a single trade. For example, if a trader has $10,000 in their trading account, they should not risk more than $100 on any single trade.

The next step is to decide the stop-loss level, which is the price at which the trader will exit the trade if it moves against them. The position size is then adjusted so that the potential loss equals 1% of the total capital when the stop-loss level is hit.

Benefits of the 1% risk rule

The 1% risk rule offers several advantages:

• Risk management: Limits potential losses and helps preserve capital.
• Discipline: Encourages traders to stick to their trading plan and avoid impulsive decisions.
• Long-term sustainability: Protects against significant drawdowns, allowing traders to stay in the market longer.

Examples of the 1% risk rule in action

Here are a couple of examples to illustrate how the 1% risk rule can be applied:

• Stock trading: A trader with $20,000 in their account identifies a stock they want to trade. They set a stop-loss level that limits their potential loss to $200 (1% of $20,000). If the stock’s price hits the stop-loss level, they exit the trade to limit their loss to $200.
• Forex trading: A forex trader with $15,000 in their account sets a stop-loss level for their trade that caps their loss at $150 (1% of $15,000). If the currency pair moves against them, they exit the trade to prevent losing more than $150.

Considerations when using the 1% risk rule

While the 1% risk rule is a powerful tool, traders should consider the following:

• Market conditions: Volatile markets may require adjusting the risk percentage to suit trading conditions.
• Trading style: Different trading strategies may have varying risk tolerances, and the 1% rule may need to be adapted accordingly.
• Account size: Smaller accounts may find the 1% rule restrictive, but it remains essential for preserving capital.

To further understand risk management and trading strategies, you might want to learn about stop-loss orders, position sizing, and the importance of a trading plan.