Risk is an inherent part of trading in the financial markets. All traders must understand and properly manage risk if they hope to be successful over the long run.
But how much risk is too much? What percentage of your account should you be risking on any single trade? There is no single answer for how much risk each trader should take. Risk tolerance is a personal matter that depends on factors like account size, time horizon, income level, and personal preferences.
However, some general guidelines experienced traders follow to help avoid blowing up their accounts.
This article will provide traders with a framework for understanding position sizing and money management to help ensure they don’t take on more risk than they can afford.
Never Risk More Than 2% of Your Account on a Single Trade.
One of the golden rules of position sizing is to never risk more than 2% of your total account equity on any given trade. If you have a $10,000 account, you should not let any trade put more than $200 of that capital at risk, even on a highly probable trade.
There are a few reasons why limiting each trading risk to 2% makes sense. First, it protects your capital from one bad trade, wiping out your entire account. No trader, no matter how skilled, wins all the time. Second, it allows you to be wrong on a reasonable number of trades while still maintaining positive growth over the long run. Studies show the best traders are right about 55-60% of the time. Risking 2% per trade means you can be wrong 4-5 times and still break even.
As your account grows in size over time due to profits, you’ll be able to risk more total dollars per trade while still keeping it under the 2% threshold. For example, with a $50,000 account, you could risk up to $1,000 per trade and stay within the 2% risk rule. Remember that the percent risk, not the dollar amount, matters most for position sizing.
Limit Total Risk to No More Than 10%
Another guideline is not letting your total open position exposure grow beyond 10% of your account size. This additional constraint is important because you may have multiple positions open simultaneously. Limiting your overall margin used or equity notional value at risk to 10% prevents you from getting into trouble if the market moves strongly against your portfolio.
Let’s look at an example. Say you have a $10,000 account and are in three positions that risk 2% of capital, or $200 per trade. Your total risk on those open positions would be 3 * $200 = $600, which equals 6% of your $10,000 account. That leaves plenty of margin for another trade before reaching the 10% ceiling on overall exposure.
Always use proper position sizing and money management rules like these to ensure your risk stays within prudent levels. That way, even if the worst occurs and you experience multiple losing trades in a row, you preserve most of your capital to fight another day in the markets.
Reevaluate Position Sizes After Major Losses
When establishing your initial position sizes, it’s wise to assume future results will match your backtested expectations or simulated track record. However, in real trading, there will inevitably be periods when results fall short of what you modeled.
During these challenging periods, it’s essential to reevaluate your position sizing rules. Any major drawdown, such as two losing trades in a row that combined exceed 5% of your account, should trigger a reset. Go back to smaller trade sizes for a while, say 1% risk instead of 2%, until you sort out what was causing the problem trades. This protects you from the natural human tendency to “over-trade” when unsuccessfully digging yourself out of a hole.
Over time, as you gain more experience and fine-tune your strategy, your performance should regress to your longer-term expectations. But resets after downswings ensure you don’t compound early losses by taking on too much risk before getting your edge back on track.
Avoid Taking Large Positions
In addition to adhering to fixed percentages of your account size, it’s also wise to avoid large position sizes altogether, especially when starting. Taking heavily leveraged trades that can move your P/L by thousands or tens of thousands on a single pip move often leads to emotional mistakes.
Instead, focus first on consistently smaller trades where your focus remains on the statistical edge and process rather than on any one trade’s outcome. Only scale up position sizes gradually as your skills and risk management improve over many trades and proving periods. Large bets also go against the spirit of preserving capital for the long haul through prudent money management.
Factor in Your Personal Risk Tolerance
While the 2% and 10% position sizing guidelines provide a strong starting point, your circumstances may call for even more conservative rules. Those close to retirement with smaller accounts will understandably want to take on less risk than active traders with more significant sums to invest. Similarly, if you have limited capital or think that drawdowns cause significant stress, you may prefer capping position sizes at 1% or lower.
Never force yourself into more risk than you’re truly comfortable with. Accepting risk is ultimately a personal choice. It’s acceptable and often advisable to adjust common parameters to fit your temperament, resources, and goals.
Key Takeaway
Determining how much risk to take is highly personal, but some sensible defaults exist. Experienced traders usually recommend risking no more than 2% of your account on any single trade and keeping total open exposure below 10%. Comprehensive risk management also requires factoring in drawdowns and your overall risk tolerance.
