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# 2% rule revisted

Discussion in 'Risk Management' started by jbob, Aug 25, 2009.

1. ### jbob

I've got a question about the 2% rule, which states that you shouldn't risk more than 2% on any given trade. What exactly do you base the 2% on? I have a catastrophic stop that rarely gets hit. Do I use this for the 2% to work backwards to determine position size. Or, do I use my average stop size of my larger losers which is usually about half of my catastrophic stop size. Or, do I use my overall average stop size, which includes the 1-2 tick losses, which would be only a quarter of the size of my catastrophic stop. Depending on which one I use, it leads to a four-fold difference in position size to get to risking only 2% on a trade. Thanks for any input

2. ### Redneck

My assumptions;

If you want to risk no more than 2% that equals \$1,000.00

\$50K (base capital) x 2% (accepted risk) = \$1K stop loss

Assuming you traded 1K shares â you would have a \$1.00 stop loss

1K shares x \$1.00 = \$1K

However to lose \$1K on 1K shares is outrageously inept â work on better entries

You can adjust either share size or stop loss price to maintain your 2% risk

If you trade multiple instruments simultaneously â then bust your account up accordingly for each instrument (capital required for each) and use above formula

Btw your catastrophic stop should NEVER exceed 2%... If 2% is your accepted risk

Preserve capital first, make money second

Hope this helps

RN

3. ### total_keops

Look for a thing called the risk of ruin.
The 2% is in fact an average for most traders but it is different for everyone.

5. ### nukethewhales31

The way i see it the 2% rule is combined with plataues. Plataues are levels where you change your position sizing but the risk vrs. reward is fixed in amount...

Example: you have 50k like RNT said ...

50K @ 2% rule first plataue of 5% over 100 trades...

lose 1k before revaluing plataue change of 5% or 2.5K revalues the account

fixed at 2% over high sample of trades =x = 100 loss amount 1k
1k/100 = 10bucks loss per trade in the plataue setup at my risk level of 2%.

SO... it should take 100 trades to push me to revalue my position and take the 2% loss.... SO... if i have a significant edge... i and the amount of trades is significant enough to push real performance with you edge... you should only be increasing the plataues... if you are decreasing plataues you have no edge or negative edge..

this creates some fundamental changes between you and other traders....

It also allows you to have a straighter equity curve with less down periods by allowing the rule of large numbers to take effect.

you also need a 15% less accuracy rate than working with % gain so less of an edge will make you profitable this is increasing efficiency in trading.

EXAMPLE:

FIXED

1:1 risk reward on fixed breakeven is at 50% = 100+5=105-5=100 BREAKEVEN

Percent based

1:1 risk reward on % base at 50% = 100+50=150-50%=75
percent base has negative expectancy at 50%

consistency and efficiency is plataues and fixed based...
% is exponential growth grows faster with higher edge but you need 15% accuracy at 1:2 to be effective as fixed will never be as efficient...
and can make or break trading either into profitability or losses...

new traders should be deff. begin with fixed based account management.

NUKE.

7. ### ScoobyStoo

Be aware also that the amount of leverage you employ must be taken into consideration. If you are highly leveraged a 2% bet has the capacity to clean you out if you are at the back of the line when everyone heads for the exits.

9. ### ScoobyStoo

Kelly doesn't apply to the markets. It assumes binomial distribution (which is incorrect) and fixed odds (which is incorrect). Great for the blackjack table (which is a valid gambling environment in which to use it), hopelessly flawed when applied to the markets.

Use at your peril. Black swans/six sigmas/whatever you want to call them type events will blow Kelly out the water.

10. ### u21c3f6

There is no one way to do anything.

I use set-ups that are binomial and while not exactly fixed odds I "know" my average risk/reward. I use half-Kelly to size my "investments". Sometimes this % is less than 2% but more often than not it is greater than 2% because I do a lot of hedging. Using a flat % rate would not work for me as in some cases it is too much but in most cases it would underperform too much.

If what you do lends itself to Kelly, I highly recommend it. I use half-Kelly because when using full-Kelly, if you overestimate your edge, you will use too high a % and be on the fast track to ruin. In addition, even if your edge estimate is correct, full-Kelly will produce some wild swings in capital that just doesn't fit my personality. To each their own.

I wouldn't dismiss Kelly out-of -hand. Look at it, if you can apply it to what you are doing, again, I highly recommend half-Kelly. If you can't apply Kelly to what you are doing, then of course you have to come up with some other "system". I know that 2% has been around for a long time so there must be some performance basis to it but I personally would feel more comfortable using a % that is tailored to the way I do things than to accept a "standard".

Joe.

#10     Aug 28, 2009
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