Is 1% risk per trade too much?

In the trading world, risk management is the cornerstone of long-term success. Many traders are taught to adopt a "1% risk per trade" rule, believing it strikes a balance between growth and protection. But is it really the optimal approach, especially when trading on proprietary (prop) firm accounts with strict drawdown rules? Let’s analyse this question using data from Monte Carlo simulations.

What the Monte Carlo Simulations Reveal

We conducted Monte Carlo simulations to analyse the impact of 1% risk per trade under different trading scenarios. Using a 70% strike rate and a sample of 1,000 trades repeated across 10,000 simulations, here’s what we found:

• The average maximum drawdown was approximately 6.63%.

• In 95% of cases, the maximum drawdown was below 9%.

• The worst-case drawdown reached as high as 17%.

These findings demonstrate that even with a high strike rate, the 1% risk per trade rule can lead to substantial drawdowns due to inevitable streaks of losses. For traders working with prop firm accounts - which often have strict drawdown limits between 5-10%, this can put their accounts at serious risk of breaching those thresholds.

Now let’s consider the implications of a higher risk level, such as 2% risk per trade:

• At 2% risk per trade, the worst-case drawdown climbed to 34% in extreme scenarios.

• Even the 95th percentile drawdown exceeded 18%, far surpassing the acceptable limits of most prop firms.

These results underscore the dangers of rigid risk rules in trading. While 1% risk per trade is widely regarded as a "safe" standard, our analysis shows that it is still too aggressive in many contexts, particularly when managing firm-funded accounts.

The Problem with Fixed Risk

The 1% rule assumes a static approach to risk: the same percentage is risked on every trade, regardless of market conditions, equity performance, or drawdowns. This rigidity can amplify the impact of losing streaks. Here’s why:

1. Drawdowns Compound: When your account is down, risking the same percentage magnifies losses relative to your equity. For example, risking 1% on a $10,000 account after a 10% drawdown means you’re effectively risking 1.11% of your original equity.

2. Limited Recovery Power: As drawdowns deepen, the percentage gain required to recover grows exponentially. A 20% drawdown requires a 25% recovery, while a 50% drawdown demands a 100% gain.

The Monte Carlo simulations reinforce this reality: fixed risk per trade doesn’t adapt to the inevitable fluctuations of trading performance and exposes traders to unnecessary risks.

The Solution: Dynamic Risk Management

To navigate these challenges, the solution lies in dynamic risk management. This approach adjusts the percentage risk per trade based on your current equity and performance trends, allowing you to capitalize on strong periods and protect your account during drawdowns.

Here’s how it works:

1. Increase Risk When Equity Is Up: During winning streaks or when your account is above a certain equity milestone, slightly increase the percentage risk. This allows you to maximise gains when you’re in sync with the market.

2. Reduce Risk During Drawdowns: When your equity is below its peak, scale back risk. For example, instead of risking 1%, you might reduce it to 0.25% during a drawdown period. This limits the compounding impact of consecutive losses.

3. Preserve Capital: Dynamic risk ensures that your risk exposure is always proportional to your current equity, safeguarding your account from breaching critical drawdown thresholds.