Do you know the 1% rule in Forex trading? Most likely, yes, this is a rule generally taught in money management courses and trading training. This rule aims to always take 1% risk of its capital per trade at most and especially not more.
Risk 1% of your account by speculative trading
The 1% rule requires that the risk taken per trade does not exceed 1% of the capital available to practice Forex trading. If a transaction does not turn to our advantage and results in a loss, the 1% rule protects the trading account and allows it to suffer a maximum of 1% of the capital. At all costs, confusion must be avoided between risk of 1% per transaction and a significant shift (greater than 1%) in the market. The 1% rule means that you will never lose more than 1% of your capital, even if the market loses 5%, for example. We can very well risk 1% of our capital with a stop loss of 10 pips or risk 1% on the basis of a stop loss of 50 pips, and it is enough at this moment to calculate the position size so that it respects the initial risk of 1% per transaction.
The benefits of the 1% rule
Eliminates the risk of ruin: Indeed, if you make a mistake or make a prediction leading to a loss, you only lose 1%. In other words, this does not greatly impact our capital and leaves us room (100 trades) to see if anything needs to be changed in our trading strategy.
Preserves capital: If we are in a bad place, limiting our risk to 1% of our capital per trade, then we will overcome this difficult period quite easily. It is unlikely that one will lose the equivalent of 100 consecutive trades.
Limits the impact of losses: Assuming that a series of 8 or 10 bad trades occur, the drawdown will only be 8% or 10% and will represent a small downward swing on our Forex trading results curve. If we had risked 5% of our capital per trade, the drawdown would have been much greater and would show a 40% or 50% loss on the trading account for 8 or 10 losing trades.
Helps keep emotions under control: Risking 1% of your capital per trade logically involves less stress than risking 5% or 10% of your capital per trade, which improves the quality of trading and avoids falling into an infernal spiral of emotional trading.
Taking the risk of 1% of your capital per trade may seem very conservative, which is why some traders push this risk to 2% per trade, but beware, it is strongly discouraged to risk. Some traders do not hesitate to reduce this risk even more and to speculate with 0.50% risk per trade, which leaves them a considerable margin of 200 trades and subjects them to less volatility in their results.
Precaution is important
Besides this rule, there are many other precautions to consider to avoid bull trap and many other market traps. Doing technical and fundamental analysis is also one of them.
The basic rule for managing risks of any kind is the historical analysis of the management strategy. You need to check the price action in the past for any strategy you want to use. The search will not take much time, but the results will improve the recommendations above. Plus, analyzing historical trading data will save you money.
In general, the process of preparing a strategy for later use can be divided into several steps:
- Getting to know the rules of the strategy
- Apply transactions to historical data
- Trade on a demo account
- Test the strategy in a live account with minimum amounts
- Adaptation of the rules if necessary
- Full use of strategy
Finally, always choose a reliable broker to avoid scams and other adversities on the market.