What you’re about to read is perhaps the best advice you’ll ever receive as a forex trader.
It’s pretty simple; only ever trade 1% of your trading account on any trade. This rule is often referred to as the ‘1% risk rule’.
The 1% risk rule is very easy to follow. For example, if you had only £100 (100%) in your trading account, only ever risk £1 (1%) per trade.
It can be used by any forex trader, whatever their experience and trading account size, obviously though 1% is a lot more for some forex traders than others.
In this article, we will explain why you should be following the 1% risk rule and explain how some forex traders follow it.
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Why only 1%?
Because your goal as a forex trader should be to be able to trade tomorrow as well as today!
It’s all about surviving and continuing to trade. If you make large trades, your trading account will evaporate very quickly.
The 1% risk rule dramatically reduces risk when trading, a hugely important factor if you want your career as a forex trader to last.
At the core of any good forex trading strategy is a good risk management strategy that you should strictly follow.
Mitigating risk should always come before making a profit; you always have to look out for what you already have. Be cautious, not greedy.
Remember that the goal of forex trading is not to make a fortune on only one trade, but to make your profit over a period of time: months, years or even decades.
Forex trading is not the same as gambling and shouldn’t be treated as such. There is no such thing as luck in forex trading.
If you lost that whole £100 in the example above in one trade, you’re out of the game and you will never see a real profit.
You would need to recuperate what you have lost in order to trade more or you may even quit trading altogether.
But by making a series of small trades, your odds of success will be higher because there are more opportunities to make a profit.
On top of that, for most forex traders, losing 1% on a trade is not a big deal, and it minimises the emotional effects of making a loss, which will affect your next trades.
Further to that, your trading account will last longer. When your trading account lasts longer, you will have more opportunities to learn and try new things to improve your forex trading strategy.
Plus, the 1% rule also makes it easier to make back what you lose in the event that you suffer a series of losses as such losses will be smaller in comparison to larger trades.
How to follow the 1% rule
The 1% risk rule is more relevant to day traders than swing traders as they trade more frequently, though many swing traders also follow this rule.
A key thing to remember about the 1% risk rule is that you should adjust the amount you will risk every time you make a trade.
Looking again at the £100 example, let’s say you lose your first trade, your trading account will now have £99 and you should now be trading £0.99 instead.
And so on and so on. That 1% is continuously decreasing with every trade you make.
Broker fees should also be considered when taking this approach. If possible, figure these all out first so you know what you have left to trade with.
Slippage also needs to be taken into consideration as well, though this is a lot harder measure, especially on days where the market is very volatile.
Forex traders should also be careful not to overuse the 1% risk rule.
There may be opportunities where it might be better to use more than 1%, though you will likely need a good degree of experience to spot such opportunities.
Further to that, you may overuse this rule by making many 1% trades to the point where you might as well of just made one big trade.
With this rule, you should also be looking to minimise the amount you trade as well. If you make ten 1% trades in a day and they all lose, you’ve lost 10% of your trading account! Not good!
If you do find yourself in a situation where you lose five or more trades in a row, remember to take a break from trading and see if you can figure out what went wrong.
There is another variation of this rule that is sometimes used where forex traders use a stop-loss.
In this variation, forex traders can decide to risk whatever amount they like but apply a stop-loss at 1% under the amount they entered the market.
This way, if they lose the trade, they have only lost 1%. This is called the ‘equal risk’ method.
Remember to consider the return too, not just the risk
Risk is not the only thing you should be thinking about. You should also aim to make a certain percentage back. In the end, your risk needs to be worthwhile.
Don’t go risking 1% on any trade, if you want to make a profit you should have analysed the market beforehand and have an idea of how much you stand to make back.
If, for example, you have the chance to make 2% or more back, then risking 1% might be a good idea.
It all comes down to your risk-reward ratio. At least aim for a return of 1:2, any less is probably not worth it and too risky.
Some traders, such as John Tudor Jones, only trade in opportunities where they believe they will be able to make five times their investment. That’s a risk-reward ratio of 1:5!
Trading in such a way also takes into consideration that successful forex traders don’t trade non-stop. In fact, they are very picky about the opportunities they get involved in.
In the end, the goal of a forex trader is to trade less not more. Trading more frequently tends to empty your trading account pretty quickly, not increase it.
Is 1% right for every forex trader?
To follow the 1% risk rule, you need a lot of will power because this is a rule that you will impose on yourself and you need to be able to stick to it.
However, not every forex trader feels the need to stick to this rule or at least follow it precisely as it is known.
Some forex traders use a variation of this rule, risking 1.5% or even 2% per trade. It partially comes down to your risk appetite.
1% may sound too rigid to some forex traders who want to make larger profits faster. However, this is not that advised.
Profits can still be made by only risking 1%. What matters most is what you make from that trade, not necessarily what you risk.
On the other hand, some more frugal forex traders may feel that risking 1% is too much. However, risking less might make trading not worth it as your return might be minuscule.
Forex traders can also consider having different circumstances for different amounts to trade. For example, if the market is rough, 1% might be the most sensible option.
But if the market is doing a little better than usual, then forex traders can think about 1.5%, and if forex traders are feeling absolutely certain about the market, they can even try 2% or more.
However, if you decide to do this, you should have set parameters put in place to follow. Don’t follow this rule based on your feelings about the market, put rules in place.
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Key points
If you remember anything from this article, make it these key points.
- The 1% risk rule means only risking 1% of your trading account per trade. For example, if you have £100, you should only trade £1 per trade.
- By following the 1% risk rule, you can reduce risk when trading. Managing your risk should always come before making a profit!
- Don’t blindly follow this rule! You should analyse the market beforehand and estimate what you are likely to make or lose.
- Some people follow variations of this rule. They may decide to trade 1.5%, 2% or more or even adjust it depending on the circumstances.
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