Defining The Five Percent Rule… Again


By Darrell Martin

In a previously published article, several traders defined the three choices a trader has when trading in order to control risk. In the article, Three Choices In Risk, Size And Stop Management, the three choices were defined as more money, more risk or percentage or having a lower tick value. This article will seek to clarify further those three choices.

First of all, no one is going to tell you it’s okay to take on more risk than is laid out in the rules or guidelines found in the forum. Taking on more risk is a personal decision that you are going to have to make. Let’s go over what the five percent rule means exactly.

The rule is: Five percent of your account size divided by six. This rule defines SIZE! Therefore, you take your account size, multiply it by five percent and then divide that number by six. This number is the maximum risk that you should take on any trade.

It does not define where your stop loss should be. (This is not a choice.) The stop loss is defined by the chart, based on the system. The markets do not care what your account size is. You must trade based on the chart, not on your account size.

What do you do if five percent divided by six is not enough to put the stop in the proper location? Should you tighten up the stop to equal the five percent divided by six number? NO! This is not an option since you will then not be following the system. (This is not a choice.)

Should you do just enough trades, possibly two or three net losses, until you hit the five percent and keep the stop on the chart? NO! This will ruin the statistics of allowing you to have the opportunity to grind profits out of the market. (This is not a choice.)

By this point, you may be feeling that you are out of choices. You can’t take fewer trades and you can’t set a tighter stop. So what can you do? Well, you have three choices that will still keep the system intact and allow the stats to work out.

  1. Trade a small tick value instrument like a Nadex Spread or Micro Spot Forex.
  2. Save money until you have the proper account size for proper risk management.
  3. Be willing to risk a larger overall percentage of your account knowing that you are lowering your probabilities of success with more risk. Sometimes this works and sometimes it does not work. As your account grows, do not increase your contract size until you can keep the five percent divided by six rule in check.

Remember that the five percent rule also applies to winning. As one experienced trader said, “We trade to live, not live to trade. Stopping at +5% allows us to step away from the computer, control greed and enjoy the rest of our day and actually have a life.”