The 1% rule says: never risk more than 1% of your account on a single trade. Risk is not the size of the position; it is the amount you lose if your stop is hit. The two are linked by the stop distance, and that link is the whole point.
The formula
Position size = (account × risk per trade) ÷ (entry price − stop price).
A worked example
Account: $20,000. Risk per trade: 1%, so $200. You want to buy a stock at $50 with a stop at $47. The stop distance is $3. Position size = $200 ÷ $3 = 66 shares. Cost of the position: $3,300. If the stop is hit you lose $198, about 1% of the account.
Now move the stop to $49. Stop distance $1, position size 200 shares, cost $10,000. Same dollar risk, three times the position. Tight stops do not reduce risk; they increase size and get hit more often.
Why 1%
Ten losing trades in a row at 1% each leaves you with about 90% of your account and a clear head. The same streak at 5% leaves 60% and a strong temptation to double up. Streaks of ten are not rare; any strategy with a 50% win rate will produce one eventually.
Adjustments that make sense
- Cut to 0.5% while learning a new strategy or after a drawdown.
- Cap total open risk, across all positions, at 3–5% of the account.
- Treat correlated trades as one: long three semiconductor names is one trade with three tickers.
Size first, then entry. Traders who do it the other way round are deciding how much to lose after they have already decided to be in.