Thursday, May 2, 2013

Managing Your Trading Risks Using The 2% Rule


“Never Risk More Than 2% of your capital on any one stock”


A very good tool that is used by successful traders and investors to limit their capital’s exposure to risk is the system called “The 2% Rule”.

The 2% Rule is a strategy where the investor limits his risks in case of a loss of no more than 2% of his total capital during a single trade.

To adopt this system, first calculate the 2% value of your available trading capital. Once this is known, we can play around this value to formulate our system based on the concept of “The 2% Rule”.

If your available trading capital is P50, 000, never risk more than 2% of P50,000. Your maximum risk per trade is P1,000.00. This amount must include the commissions and charges during the trade.

Using the 2% Rule, we can now put a safety limit which we can call the Stop – Loss Point on our trading to protect our investment from downside risk;

For illustrative purposes, let’s compute the S/L (Stop-Loss) Point using the 2% Rule given the example below.


EXAMPLE:

You have bought 2,000 shares of ABC stocks at P5.00 per share. Your capital cost is equal to 2,000 shares x P5.00 per share = P10,000.00.

Applying the 2% Rule, your Allowable Loss should not be more than P1,000.00 based on your available trading capital of P50,000.

To establish your S/L (Stop-Loss) point, let’s compute the following:

Assume Total Brokerage Charges = P102.30


S/L Point  = Capital Cost – (Allowable Loss – Total Commission charges)/ Total Shares bought

S/L Point = P10,000 – (P1000 – P102.30) / 2000

S/L Point = P4.55 per share