One Percent Rule: What Is It?

What is the One Percent Rule?

Many experts suggest that as a rule, individual investors should set their loss floor for a trade at the equivalent of one percent of their total liquid net worth.

For example, according to the One Percent Rule, if you had a liquid net worth of $100,000, your loss threshold should not exceed $1,000 on any one particular trade. In other words, the maximum amount that you would be willing to lose on a single trade would be $1,000 from your $100,000 portfolio.

When you plan a trade, you should already be considering your exit strategy. Among the elements of any comprehensive exit strategy is a decision about the maximum tolerable loss level. If the maximum acceptable loss on the trade works out to be less than the amount suggested by the One Percent Rule, no further action would be needed. But, if the loss exposure on the trade is greater than the amount suggested by the One Percent Rule, the stop-loss order should be recalibrated. Instead of the originally planned amount, the order should go into effect when the One Percent Rule threshold is reached.

This process can serve as a valuable reality check on the assumptions of the trade.

However, if the One Percent Rule results in the stop price being set too close to the original buy price you may want to consider purchasing fewer shares to allow for greater price movement. In such a case, the investor is probably allocating too great a portion of the portfolio to that particular trade, and the proper response is to reduce the number of shares to whatever amount produces a more realistic stop-loss level.

The One Percent Rule can serve as the basis not only for individual trade decisions, but also for creating a master strategy for helping to manage the risk in your portfolio.

To learn when the One Percent Rule may be appropriate for your investment strategy, click on the Why and When tab in this module.

To learn how to use some of the tools appropriate for the One Percent Rule strategy, click on the How To tab in this module.