Risk Management · Lesson 8 · Beginner
The 6 Percent Rule and Drawdown
You know your monthly risk budget and understand that losses are asymmetric.
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The monthly brake
Elder: if your equity in a month drops more than 6 percent below the previous month's closing balance, you are done for the rest of the month. A forced cooldown.
You calculate available risk as realized monthly losses plus your currently open risk. Paper profits do not count as a buffer.
See how much gain a drawdown needs to recover.
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Test yourself
Your account drops by 50 percent. How much gain do you need for a full recovery?
- 50 percent
- 100 percent
- 75 percent
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The key points at a glance
- Minus 6 percent in a month means you stop trading until month end.
- Available risk = realized monthly losses plus open risk, paper profits do not count.
- A 50 percent drawdown needs a 100 percent gain to recover.
Deep dive
How the 2 percent and 6 percent rules work together
Elder combines two meshes into one safety net: the 2 percent rule caps the damage of a single bad decision, the 6 percent rule caps the damage of a bad streak. Three full losses of 2 percent each, and the month is over.
This forced cooldown is the most important part. Paul Tudor Jones trades his smallest size precisely when he is trading his worst. Losing begets losing: losing triggers tunnel vision, and that is where the worst decisions come from.
Drawdown recovery: the sobering table
Losses and gains are not symmetric, and the deeper you go, the more brutal the asymmetry becomes.
- A 10 percent loss needs 11 percent to recover.
- A 25 percent loss needs 33 percent.
- A 50 percent loss needs 100 percent, you have to double.
- A 90 percent loss demands a 900 percent gain, practically unrecoverable.
- Bitcoin fell about 77 percent in 2022, many altcoins over 90 percent, Terra/Luna to zero.
Why your risk budget grows month by month
The limits are percentages of your equity at the start of the month, not fixed amounts. When the account grows, the absolute limits rise with it, when it shrinks, they fall automatically.
Available risk is the sum of realized monthly losses plus the risk in open trades. Paper profits do not count as a buffer. The rule only cares about drawdown, it is a brake, not an accelerator.
Sources: Elder, Schwager, Taleb, Goodman, Burniske
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