Trading Risk 2%: Why Old school forex method is better

How much a trader should risk per trade, is a crucial factor in terms of trade money management system. The most common myth spreads all over the web or told by the majority of the pro traders is risking only 2% or less per trade.

Although some traders might disagree with it. Among them, legendary trader WD Gann himself has persistently repeated to risk 10% per trade. Because he had the highest strike rate of winning. He was convinced that he will never lose 10 out of 10 with his trading strategy. So for him that works!

But the question is will it work for you? Let us discuss this in detail from a statistical point of view.

Statistical point of view:

Suppose as a forex trader, if you risk 2% with an $1000 account and you winning profit is 4%, (1:2 Risk reward ratio), winning chance 50:50. Then after 10 days you can earn $1342.92 with daily 3 trades.

trading risk 2%
Forex trading risk 2% profit

Now with same 1:2 risk reward ratio, when user risked 10% and with 30% wining rate. Then above position curve changed into negative.

trading risk more than 2%
Forex trading risk 10% per trade

Well, most of us are not extraordinary. For some trader risking 10% per trade is simply overconfidence & gambling, especially when you do not know what you are doing. Plus WD Gann did not trade modern Forex market.

If you are a Forex trader, then it’s worth risking 2% per trade. Currency exchange is a highly liquid asset class. Thus it provides lots of opportunities to make a reasonable profit even with 2% per trade risk.


Related Links:

Rate of return calculator

Two Major Benefits of risking 2%:

Following are the two major factor that positively influences trader to take low risk.

1. Free from Mental Trauma:

2% per trade provide some mental peace & you will be under less trading stress.

2. Statistical Backup:

With 2% per trade risk, you will have 100/2 = 50 attempts to make before losing the whole account. 50 attempts are enough room for a trader to handle the drawdown psychologically.

Drawdown Recovery Percentage Table

% Loss of Capital % Gain Required to Recover Loss
10% 11.11%
20% 25%
30% 42.85%
50% 100%
60% 150%
70% 233%
80% 400%
90% 900%
100% Bankcrupt

From the table above you will see, if you risk 10% per trade & made 5 consecutive losses, then your total loss will be 50%. That means you have to gain 100% to reach breakeven. That’s a huge pressure!

But with 2% risk per trade & 5 consecutive losses, you will only lose 10% of your trading account. Therefore you just need 11.11% return to reach the breakeven. Comparatively less stressful isn’t it?

Effect of consecutive losses

A trader might say, I can not get 5 consecutive losses, my strategy is bulletproof. Honestly, all strategy fails under certain market conditions. That’s natural. So when you do the position sizing, you need to keep the worst-case scenario in mind. There can be some days where you get a 50% win rate or less.

Multiple Losing Streak Probability Calculator
Source: daytradinglife (Multiple Losing Streak Probability Calculator )

With the excel calculator below by daytradinglife, we can see a 50% win rate statistically has chances of having 5 consecutive losses is 18.26% under the batch of 15 trades. When the number of trades will increase, this losing chances will similarly increase too. You can download this excel spreadsheet with the link below to calculate further:

Dependency on Risk/Reward Ratio:

Generally, if you have a trading strategy where your Risk/Reward ratio is double, say 1:2. That means if you risk 2% you will get a 4% profit back. Therefore with a 50% win rate for 10 trades samples, you can actually make a 10% return on your account. With a higher winning rate, you can earn even more, just only risking 2% per trade. Refer to the example below:

forex trading profit
Forex trading profit with 1:2 ratio for 100 days 50% win rate

Money Management:

How much you will risk per trade that completely depends upon the trader him/herself. Because of mostly a trader with a small account size tends to risk more than 2% per trade. Which indicates a sort of gambling mindset to grow the account faster. Sometimes in order to ensure a larger return, they lost the whole account money. Which is commonly known as “Blowing account”.

But with proper discipline, a trader gets a positive long term curve in this trading account balance, as shown in the first example.

Is it possible to lose whole account value using 2% per trade risk?

Basically, with 2% per trade risk, you can generally get 50 attempts to lose the whole account value. No one can ever lose 50 out of 50 trades. Even if you trade with a coin-flipping method, still you will have chances of winning & losing 50%.


External Links:

Coin flipping simulator

But yes in the case of trading you need to consider brokerage charges for each of your trades. Even with 2% per trade risk & 50% win rate, you can eventually create a downward graph, if you have a risk-reward ratio below 1:1. This means you will lose more to earn less.

Also not to mention overtrading. Adding trade by trade at the same price zone or trading during a range market or fluctuating market is not always a good idea. There are some market conditions when no technical analysis works. Those are the time to avoid trading as the market is in no man’s land.

Once You avoid over trading, cutting profit early & letting the loss run longer. You will see you are never blowing accounts. You are giving yourself time to learn & succeed.

Conclusion:

There is no fixed rule for how much one should risk. It all depends upon the trader risk appetite. If you can accept a bigger loss with a bigger risk, then no issues. Big risk = big profit, small risk = small profit.

The only things that make a difference are the winning rate of the trading system and maximum consecutive lose. If a trader has an average of 5-8 consecutive losses, then going with lower risk is always a better option. After all its all about mathematics & physiology.

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