The majority of professional traders, who have come a long way in the field of trading, are using the 2% rule. In this article, I will share in detail how to use this rule to manage money in trading.
What is the 2% rule in trading?
The 2% rule can be simply understood that you can only lose up to 2% of the total money (capital) in your account for 1 trade.
Example 1: Your capital is $1,000. So you can only lose up to $20 in 1 trade as shown in the photo below.
You open a SELL EUR/USD trade and the Stop Loss level is 20 pips. After applying the 2% rule, the trading volume for this SELL order will be 0.1 lots.
Example 2: The money in your account is $3,000. The maximum loss will be $60. Let’s say you open a BUY GBP/USD trade with an SL of 40 pips => The trading volume for this BUY order will be 0.15 lots.
How to calculate lot size (trading volume)
The market has a lot of different currency pairs for you to trade, so the application of the 2% rule will also be different. To make it simple, I will give you a tool to calculate it called Lot size calculator.
It’s very simple to use. You just need to fill in some information such as account balance, risk, stop loss pips, and trading currency pair.
For example, my capital (account balance) is $30,000. I enter 2% risk, 60 pips stop loss and the trading currency pair is EUR/JPY => The trading volume is 1.1 lots.
The question now is: How much is the Take Profit?
What will the take profit level be? This depends a lot on your trading strategy. I will give some specific cases for you to understand and be flexible when using the 2% rule.
Case 1: Do not set a specific TP level
It means you only set the Stop Loss (SL) level according to the 2% rule. When the price moves in the right direction, you will move the SL (Trailing Stop technique).
For example, I used the EMA21 trading strategy and the daily chart to enter orders.
When the price broke out and closed above the EMA21 => I opened a BUY order and set the Stop loss level below the Breakout candlestick (80 pips).
This order only ended when the price closed below the EMA21. There was no clear Take Profit level.
In this kind of trade, if I’m wrong, I will lose 2% of my capital. But in case I’m right, the profit will be huge. With this BUY EUR/USD order, I made a 6% profit. This is the way experienced traders use to catch a long wave in the market.
Case 2: Partial close
Simply put: Your maximum loss is 2%, and your profit-taking level depends on your psychology (Partial close technique).
For example, I use the Fibonacci indicator to identify take profit levels.
- BUY EUR/USD at 1.18621
- Stop Loss: 1.18121 (50 pips)
- TP1: 1.19747
- TP2: 1.20370
- TP3: 1.22386
My capital is $5,000 => 2% = $100. So my trading volume will be 0.2 lots. And when the price hits the TP1, I will close partially to gain some profits.
Case 3: Use Risk/Reward ratio
This is the Risk/Reward ratio (R:R) with 1R = 2% of the account balance. Usually, traders who use R:R only open orders when the expected profit is greater than 2% of the account, corresponding to the ratio R:R = 1:2 (1 risk for 2 profits) or higher.
For instance, I have a BUY order with EUR/USD. Stop Loss is 20 pips and Take Profit is 40 pips (corresponding to the ratio R:R = 1:2). My capital is $1,000 then the trading volume will be 0.1 lots. If my prediction is correct, I will have 40$ (2R) profit. Conversely, if wrong, I will lose 1R = 20$.
Above are some examples of how to manage money according to the 2% rule. You can vary depending on your Forex trading method and strategy. But remember that Only a maximum loss of 2% of the account balance is allowed.
Review the 2% rule
Why do most professional traders use this rule to trade? Why is the rate 2% of the account but not 3% or 5%?
I can’t exactly explain the above question. But when I use this rule, it really works. Now I will share my reviews.
In Forex trading, a Trader’s account status will fall into the following 5 cases.
(1) Big loss (Probably burning account)
(2) Small loss
(3) Break even
(4) Small win
(5) Big win
In trading, sometimes you may even experience a long losing streak. But when you use the 2% rule to manage your money, your account will only fall into 4 cases including small loss, breakeven, small win, or big win.
Just imagine when you are wrong, you only lose a small amount or break even. But when you’re right, either you win small or win big.
So, in 10 trades, you can:
– Lose 6 orders in a row (-12%)
– Draw 2 orders (0%)
– Small win 1 order (+4%)
– Big win 1 order (+10%)
Summary: You still have a profit of 2% of the total capital.
Honestly, I don’t know exactly why the rate is 2% and not another number. I will try to use my experience to explain.
– 2% of the account balance is a small number. The psychological pressure and fear of losing money are not too heavy. This gives you more confidence in your decision-making process.
– 2% is a reasonable number for you to survive in the market. Lose 10 trades in a row? That’s okay because you’ll still be able to start over. Opportunities forever come to those who still have money in their pockets.
– 2% creates a long-term mindset. Most people who come to the Forex, Coin, or stock market want to get rich quickly. And as a result, they burn a lot of accounts and tons of money.
But if you apply the 2% rule mindset, you will find the market is not as difficult as you think. Just be patient, you will make money in the long run.
Difficulty of the 2% rule
The biggest difficulty when I use the 2% rule to manage money is Discipline.
It’s very difficult to be strict with yourself. The market gives people the fear of being wrong and the fear of losing money. When faced with those, many traders won’t cut their losses. They forget the 2% rule and hope that the price will bounce back. And the result is nothing left in their accounts.
May this post helps you in your trading path. With the 2% rule, I believe you will definitely survive in this market. As long as you survive, profits will come naturally in the long run.