Before you begin a trade, you should have an idea of where you need to cut loss. Let's say you have $100,000 cash and you wanted to buy a stock priced at $1.00. Suppose that the cut loss for that stock is at $0.90. The potential loss is $0.10 (1.00 - 0.90). Since 2% of your equity of $100,000 is $2,000, you can at most lose $2,000 on any trade. We can thus calculate backwards to determine the position sizing of this particular trade in order to limit the loss to a maximum of $2,000. We'll take $2,000 divided by the potential loss of $0.10, and we get 20,000 shares, or 20 lots.
So if you buy 20 lots of the stock at $1.00 and if the price drops by 10% (0.1/1.00), the loss is just limited to $2,000, which is just 2% of our total equity. By following strictly to the 2% rule, you will prevent any one trade from wiping you out. In fact, you'll need 50 such trades before your whole capital is wiped out. Unless you un-wisely choose to enter 50 positions in one go.
Variables will be the number of lots and the percentage of price drops. The absolute amount ($2,000) will be contstant.
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