Two percent rule: Fixed Fractional Position Sizing

Position sizing is important so that you do not risk trading too much of your funds, with the consequence that when losses come, as they inevitably will, your account is depleted so much that you will find it difficult to get back to the starting amount, or may even be unable to trade again. There are several methods of position sizing, and the most well known one is probably fixed fractional position sizing, a conservative method.

To do any position sizing, you have to make certain assumptions about your intended trade or spreadbet. These flow naturally from your initial assessment of the trade to make. For instance, when you place an order, the next thing you will do is place a stop loss to take you out of the order for a measured loss, if the trade runs against you. Some brokers will set automatic stop loss orders for you, but you should be involved in deciding how far the trade may run against you but still have the chance of turning out a winner. The level is commonly set by some sort of technical analysis, whether it is identifying probable support and resistance levels, allowing some multiple of average true range (ATR) from the start, or simply a set amount or percentage off the price.

However the stop loss is placed, you can calculate in conjunction with it just how much you could lose on the trade for a given stake. Stop losses are not guaranteed, and you may find that the trade exits at a lower level, and if the financial security you are using frequently does this, you may want to include an additional margin.

Fixed fractional position sizing works on the basis that the amount of loss that, if repeated several times, would cripple your account can be determined, and is a constant percentage (fixed fraction) of your account. The figure commonly used is 2%, although you will see different values depending on traders’ risk profiles.

One of the assumptions is that you have an inherently profitable spread betting system, so that you will not keep losing 2% with no wins and run out of money anyway – but you should be reasonably confident that your trading strategy will win, otherwise you would not be trading your money in the first place. Two percent is in the nature of a rule of thumb, as it is impossible to predict in advance how many consecutive losses you may suffer; but it is a number that has proved realistic over the years.

Although this is regarded as a conservative method, it is worth noting that the system means that when your account grows, as it should over the course of trading, you have a larger possible loss available. You always recalculate the possible loss for each trade.

Fixed fractional position sizing has stood the test of time, although there are always other suggestions aimed at maximising the account growth; the fact that the newer methods are usually touted as ways to increase your account size more quickly tends to support the view that fractional position sizing is working, and achieving its objective of  keeping you in the game.

Risking an amount not exceeding 2% of your trading capital per spread trade is one standard starting point when setting up your risk management plan. Some experienced traders believe that this is too much, while others believe it is too conservative particularly for small account sizes but it is a good starting point nonetheless.

2% per trade risk formula

Account size x 2% = risk amount per trade

£10,000 x 2% = £200 amount per trade

Your trading system would obviously need to produce more winning trades than losing ones. You would need approximately 60% winners. This isn’t linked with leverage, as you can use leverage and still stay within 2% equity of your account