The 2% and 6% Rules

Filed under: Learn Forex Trading |

In his well-known book, “Come into My Trading Room”, Alexander Elder outlines some very simple rules for money management and I would like to go over those rules with you now. On the face of it, they do seem like very simple rules, but they go a little deeper than you might expect. So without further ado, here are the rules:

 

1) Never risk more than 2% of your bank on one trade.

 

2) Limit your monthly drawdown to 6%.

 

Now, the first rule is fairly simple to grasp. You must not risk more than 2% on any single trade. This is axiomatic. That does not mean you have to risk 2% on every trade, on the contrary. A risk of 1% or even 0.5% would probably be more sensible. The second rule – that of limiting your monthly drawdown to 6% needs more explanation. The idea is to stop you over-trading. If your monthly drawdown reaches -6%, then you have to stop trading for the rest of the month and review your trades! This is very much what would happen if you were trading at an institution. It forces you to only pick the very best trades, as you don’t want to be sat around for the rest of the month watching good trade opportunities go by.

 

In order to follow the 6% rule you must manage your trades better. If to begin with, you have two trades on each risking 2% of you bank, that means you only have 2% to play with as those trades might fail. So you can put one more trade on risking 2%, or two trades each risking 1%. Or, if at some point you are up by 4%, then you can put five trades on each risking 2%. I think you get the picture. Never be a position where you can exceed your -6% monthly allowance.

 

So that’s it, the 2% rule and the 6% rule by Alexander Elder – the solution to good money management. I use it – so why don’t you?

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