Traders always attempt to minimize their losses. A common solution is never risking more than 2% of your capital on any single trade. This is known as the 2% Rule.
Imagine you have $10,000 in capital. At some point, you may go on a lengthy losing streak and fail in ten straight trades. If you risk 2% of capital each trade, your balance will end up being $8171. Risking any more would result in much greater losses. For instance, you will only have $5987 left if you prefer a 5% policy.
Let’s illustrate how to use the 2% Rule in the foreign exchange market.
Step 1: Calculate 2% of Your Capital
This will be necessary every time your balance changes. Simply multiply all available funds by 2%. If you have $200,000 in capital, $4,000 is the most you should risk on any trade.
Step 2: Use Entry and Exit Points to Find Risk
After you determine the appropriate entry and exit points for a trade, you can measure its risk.
To calculate risk, find the difference in pips between the entry price and stop loss. A pip represents 1% of a cent for the vast majority of currencies.
Step 3: Determine How Many Lots To Trade
Forex traders tend to trade in lots. The standard for a lot is 100,000 currency units. It is also common to trade with mini, macro, or nano lots which are 10,000, 1,000, and 100 units, respectively.
Let’s say that after measuring your trade’s risk in pips, you convert it into dollars and realize that you could lose $400 per lot. This is 1/10th of the $4,000 you calculated in Step 1.
So, if you use the 2% Rule in this scenario, do not trade more than 10 lots at once.
Implementing the 2% Rule hedges losses and protects your capital. Make sure to follow these steps to correctly apply the policy to forex trading.