We all know that the goal of trading is to make money. So far, we have learned that as long as you have an edge in the market, you will be profitable in the long run. How do you maximize your profitability without blowing up your account? The answer lies in the 2% money management rule. Let's say you have $10,000 to bet. You are considering a particular trade with a hit rate of 60%. If you bet your whole capital, you have a 60% chance of doubling your money. Let's say you split your capital into two bets of $5000 each. Your probability of losing two bets in a row is only 16%
If you use the 2% rule, you will only bet $200 per trade. Not only does this put a firm manageable cap on how much money you can lose per trade, it virtually eliminates your chance of losing everything. The risk of a trade is calculated by taking the difference between the entry price and the stop-loss price, and multiply the quantity traded. With the 2% money management rule, the only way to lose all your trading capital is to lose 50 times in a row. The probability of that happening is less than 1 quintillion percent.
As a money manager, your focus should not be on making the most money, that is what a gambler does. Your focus should be on ensuring that you do not lose your capital. It is like Warren Buffett once said. The number one rule is to not lose money. There are always stories of traders blowing up their account. If you stick to the 2% money management rule, it is virtually impossible for you to do the same. Not only that, it will also improve your trading results across the board.