What is the Perfect Investment Amount: Let’s start with a small example. Imagine two traders. Trader A can boast 50% of trades won, $200 average profit and $100 average loss. Trader B has a 75% success rate, but also has an average profit of $100 and an average loss of $400. It’s easy to see that in the long run, trader A, despite being less successful in terms of victories, will win, while trader B will finish off all his money.
What does it mean to you? In trading, it is usually more important not to lose what you have to gain more. Countless traders, investors and industry experts have dedicated their time to the problem of risk management and, in the end, have come to a conclusion that seems to be the most commonly accepted. It turns out that the first thing to consider is the amount of money you can afford to lose in a single trade.
But exactly how much is this amount? Should you risk $10, $100 or $1,000? No! Most professional traders believe that the amount of money you should spend on a single trade is not fixed, rather it should be a percentage of the entire budget you have available to trade.
Opinions differ as to the percentage you should choose. Some say it should not exceed 3%. But according to the most conservative approach, it should be as little as 1%. The 1% rule may be interpreted differently – some say you should not invest more than 1% of your entire balance in a single trade (since you may lose all your investment), others believe that as long as you are able to manage the risks properly, you can spend any amount of money, but you should close it as soon as your losses reach 1% of your entire balance. If you are more inclined towards the second formula, you can invest a higher percentage (up to 100%) but you must close the operation prematurely in case your losses reach 1%. This is where the ‘Stop-Loss’ functionality comes into play.
No one is able to win 100% of their trades. That’s why it’s essential for the trader to make sure he doesn’t lose what he can’t afford to lose. When you use the ‘1% rule’, you have to lose 100 trades in a row to completely clean up your account, so there’s plenty of room for error.
But is it possible to make money by trading with an investment of only 1% of your trading capital in each trade? Most professional traders believe the answer is yes. By risking less and earning less, you are actually pursuing a more consistent trading strategy, which can therefore move you from substantial but almost random profit/loss to less surprising but more stable profit/loss.