2% Rule

What Is the 2% Rule?

The 2% rule is an investing strategy where an investor risks something like 2% of their accessible capital on any single trade. To execute the 2% rule, the investor initially must compute what 2% of their accessible trading capital is: this is alluded to as the capital at risk (CaR). Brokerage fees for buying and selling shares ought to be considered into the calculation to decide the maximum permissible amount of capital to risk. The maximum permissible risk is then partitioned by the stop-loss amount to decide the number of shares that can be purchased.

How the 2% Rule Works

The 2% rule is a restriction that investors impose on their trading activities to remain inside determined risk management boundaries. For instance, an investor who utilizes the 2% rule and has a $100,000 trading account, risks something like $2,000-or 2% of the value of the account-on a specific investment. By understanding which percentage of investment capital might be risked, the investor can work in reverse to decide the total number of shares to buy. The investor can likewise utilize stop-loss orders to limit downside risk.

If market conditions change, an investor might carry out a stop order to limit their downside exposure to a loss that just addresses 2% of their total trading capital. Even on the off chance that a trader encounters ten continuous losses, utilizing this investment strategy, they will just draw their account down by 20%. The 2% rule can be utilized in combination with other risk management strategies to assist with safeguarding a trader's capital. For example, an investor might stop trading for the month on the off chance that the maximum permissible amount of capital they will risk has been met.

Utilizing the 2% Rule with a Stop Loss Order

Assume that a trader has a $50,000 trading account and needs to trade Apple, Inc. (AAPL). Utilizing the 2% rule, the trader can risk $1,000 of capital ($50,000 x 0.02%). In the event that AAPL is trading at $170 and the trader needs to utilize a $15 stop loss, they can buy 67 shares ($1,000/$15). In the event that there is a $25 round-turn commission charge, the trader can buy 65 shares ($975/$15).

In practice, traders must likewise consider slippage costs and gap risk. These can bring about events that make the potential for loss essentially greater than 2%. For example, on the off chance that the trader held the AAPL position overnight and it opened at $140 the next day after an earnings announcement, this would bring about a 4% loss ($1,000/$30).

Features

• Stop-loss orders can be carried out to keep up with the 2% rule risk threshold as market conditions change.
• To apply the 2% rule, an investor must initially decide their accessible capital, considering any future fees or commissions that might emerge from trading.
• The 2% rule is an investing strategy where an investor risks something like 2% of their accessible capital on any single trade.