1. The importance of the 2 percent rule and 6 percent rule

1.1. Talk about the 2% rule

Beginners are readily lured by technical indicators, but skilled traders understand the importance of money management. The 2 percent and 6 percent Rules are the two foundations of risk management. According to the 2 Percent Rule, you should never risk more than 2% of your account equity on a single deal. This regulation is frequently misunderstood, and people ask why a person with a $100,000 account may only buy $2,000 worth of stock.

You can buy a lot more, but you can’t risk more than $2,000 in any one transaction. It’s simple to compute the maximum number of shares you can purchase or sell short if you know your entry price, stop level, and risk tolerance. Assume you’re purchasing a $12 stock with a $10 stop loss. You can acquire up to 1,000 shares because you’re risking $2 per share and your maximum risk is $2,000. If you want to buy a lesser position, do so, but never exceed the 2% limit.

1.2. The importance of the 6% rule

The 6 percent rule states that you may never expose more than 6% of your account equity to the risk of loss. For example, if you trade a $100,000 account with a $1,000 risk each trade, you can only have 6 open trades at any given moment.

Let’s say you lose money on two deals; you’re now only allowed to have four active trades. You’ve already lost 2%, leaving you with only 4% open risk for the remainder of the month. When you’re on a winning streak, this rule permits you to make more transactions, but it slows you down when you’re losing money.

A solid trade starts with a money management question: Can I trade under the 6% Rule? Do I have sufficient risk in my account? If you answered yes, you can use your method to assess the stock. Then, just before you put an enticing trade on, go back to money management and ask: Based on the 2% Rule, how many shares may I buy or sell short?