There is a common mode of thought when it comes to day trading and the risk management involved in doing it. ‘The one percent rule’ is usually the most common form of thinking that Is followed.
Essentially this rule states that only one percent of your account total can be put towards any trade that you are pursuing. Essentially, keeping your losses to a bare minimum.
Doing this rule and becoming proficient when it comes to risk management is an essential skill to have in your arsenal as a trader. To ensure that you are consistently earning a healthy income over your near and far future, it is of utmost important to try and keep your losses to your capital to as bare of a minimum as humanly possible.
Whenever your losses begin to deepen more and more, your psychological strictness and control will become ever more important in your trading life.
Becoming broader in your trading ability is also incredibly important as you do not want to be putting all your eggs in one basket in the event that that one basket per se goes against you.
One Percent Rule Example
This rule always ensures that as a trader, no more than 1% of your total value of your account will be used on anything you invest into. Leverage is allowed to be deployed, however the loss stops if it reaches 1% liquidation value of your account total.
Let us say you have a total of $20,000 in your account as an overall total:
(1) This will essentially limit your position on your trade to $200.
(2) You will be able to deploy leverage so that you can exceed the $200 amount, however your stop-loss on trades so that any losses you may encounter may not exceed the $200 amount.
How to Apply the One Percent Rule
It is important to manage to calculate it yourself ahead of time to ensure that you can deploy the rule beforehand.
Let’s say a stock you have interest in trading is priced at $20.00.
If you start at a trading price of $20 and you go with the stock of $19.90, this will ensure that your profit is $20.05 as well as your stop-loss being $19.85. If your account value is at a total of $20,000, then what would the total amount of shares you could purchase be if you were following within the guidelines of the 1% rule.
You must first take into account the maximum you can lose on a trade such as 20,000 at 1% which would be $200. Your max loss in this scenario is 0.05. So, $200/0.05 per share would come in at around 4000 potential shares that you would be able to set yourself for purchase.
Exceptions from the One Percent Rule
Any potential outliers to the 1% rule would always depend on the market of the trade that you are taking part within.
However, for the markets that are not liquid markets, then it is a high chance that the markets would have the opportunity to go out of your favour along the way.
But regardless of the scenario that you may find yourself in as a day trader, it would seem odd to find yourself in a situation where you are going to risk 1% of your account value total on a singular trade that has peaked your interest.
This 1% rule is not a given, and obviously it can be morphed to suit whoever is wishing to try and use it. However, it is always important to attempt to calculate how much in total you would be willing to lose on a singular asset, rather than going in completely blind. If you were wanting to play safe and smart, then staying within the 1% range is something that cannot be emphasised enough, as losing multiple situations back to back could still only add up to a combined 6% total loss at the end of the day, which is something that could be recovered from if played correctly.
If you are looking to know if you’re trading too high of amount then just consider how your trading has left you in terms of your emotional state.
- If you are overly focused on charts and price movements.
- If you are overly nervous or anxiety-stricken at the thought of trading.
- Over reactions to market situations, such as immense sadness or joy at how the market moves in a particular direction.
If any of these apply to you when trading, then you must lower the amount you are trading as it will have a dangerous tole on your mental and emotional state in the long and short term.