Two Percent or Die

Submitted by Marco Palmero on 7 April, 2008 - 08:57

Two Percent or Die - Daytrading Risk Management

Two percent money management is very important especially when you are daytrading and actively trading the markets. Lets take a look at a tale of two traders with this table. You must apply the two percent rule with due diligence: that’s two percent or die. Examine the case study table below:

Dumb Trader Smart Trader
Starting Capital $10,000 $10,000
Loss of 35% $6,500 $9,800
Loss of 45% $3,525 $9,604
Gain of 35% $4,826.25 $12,965.40
Gain of 45% $6,998.06 $18,799.83

Let’s tell a tale of two traders. One is Dumb Trader who doesn’t have a money management system. The other is Smart Trader who absolutely loves his 2 percent rule and applies the rule sensibly with every trade. Let’s say both choose the same trades based on the same principles: they have the same technical/fundamental trading strategies. The only difference is their risk management strategies. To keep this simple, let’s say the traders were only trading one stock at a time but they both executed the same trades at the same time. The table shows a string of four trades: one is a major loss of 35% when Mr Dumb decided to exit because he couldn’t bear any more pain and lost $3,500. Mr Smart exited because the stock fell beyond the support level, where he had placed a stop loss according to his 2 percent trading risk strategy – only losing $200. Another loss was taken in the next trade. Mr Smart bailed out with his system early on the game and lost only $196. Mr Dumb held on to the trade wishing it would rebound, but at 45% his emotional state was breaking down and he had to exit the trade – he lost $2,925.

Now both traders see a little luck. Now comes a string of profitability. A gain of 35% on the underlying stock price saw Mr Dumb’s portfolio grow by $1,251.25. While Mr Smart who preserved most of his capital through the stormy trading season reap $3361.40. The next trade saw a 45% increase and so Mr Smart’s portfolio shot up to $18,799.83 while Mr Dumb Trader had $6,998.06. After four identical trades the two traders ended up with very different results. Mr Smart Trader almost doubled his account because of the two percent rule, while Mr Dumb Trader managed to lose about 30% of his account. That’s that the two percent rule does. It preserves your capital for the better days and allows you to survive in the trading game for longer. And it also increases your profitability as a result of preserving more of your capital!