Why the 1 % rule is the most important rule in trading

The 1% rule is an axiom in trading that you will hear from mostly all trading gurus or teachers as being the most important rule that you could possibly follow. So the question is why don't you trade above that amount and achieve faster success?

The answer is largely in long term probabilities. In order to trade or invest successfully you must preserve your capital over the life of your account. Therefore you need to properly understand risk and probabilities. All winning strategies play out over a large number of trades and all wins and losses are randomly distributed. Even if your strategy is good over a larger number of trades, you still can't predict the order of your wins and losses. You can easily lose 5 trades in a row and still have a winning strategy, but if you're risking 5% per trade that becomes a 25% total equity draw down. If you risked 10% per trade you would be down 50%. Try thinking straight when that happens. This is certainly why many traders blow out their accounts. They get on an inevitable but normal losing streak and lose the ability to implement their strategy properly because they've already blown their accounts.

Another factor that's important is how large equity swings affect your ability to think properly. Making and losing money affects you emotionally. When you win a lot of money you get really happy and excited, and when you lose a lot you can get down on yourself for making a silly decision. Even if you're implementing a relatively small risk of let's say 3% per trade you can incur large wins or losses and you run the risk of becoming too emotionally attached to your trades. This will hinder your ability to make the right decisions when trading and you probably wont be able to execute your winning strategy properly.

However, if you only risk 1% of your account equity per trade wonderful things start to happen. Firstly, it'll be impossible to blow your account with a winning strategy because you're giving your strategy time to actually work over a large pool of trades. On a psychological level you'll be much more emotionally stable because you won't have to deal with large draw downs or even huge wins, giving you an objective edge. You'll be less hesitant when deciding whether or not you should take a trade and you won't suffer from issues such as FOMO or fear to take another trade because you've won or lost a large sum on your last trade. You will become more focused on simply winning over the long run rather than the nominal outcome of your next trade and surprisingly that will enable you to trade better.

We hear that most traders actually lose money in trading, some break even, and about 5-10% of traders actually make money in the long run. The traders that make money in the long run are those who are more than likely practicing safe money management techniques. I would be hard pressed to believe that the best hedge fund managers in the world are taking large risks on single trades. On the other hand they understand that the most important factor in trading and investing is to preserve capital and to avoid making mistakes that can cause large equity swings. They know that they need to stay alive as long as possible to trade the best that they possibly can, and that's why they're the best at what they do. Once you accept this and implement it you can start trading better too. Go ahead and give it a try, you'll be amazed to see the consistent returns you can make on a quarterly or even monthly basis.

Thanks for reading and feel free to leave a comment :)