The 5% rule is a risk management strategy that helps traders and investors limit losses and maintain portfolio stability. It has two key applications:

Position Sizing – Never risk more than 5% of your total trading capital on a single trade. This ensures that even a losing streak won’t significantly deplete your account. For example, if you have 10,000, you shouldn’t lose more than 500 on any one trade.

Portfolio Allocation – Avoid allocating more than 5% of your portfolio to a single stock. This prevents overexposure to one company’s volatility, reducing the impact of a sudden downturn.

Why Follow the 5% Rule?
Protects Capital – Prevents catastrophic losses from bad trades.

Reduces Emotional Trading – Encourages discipline by culling excessive risk-taking.

Improves Long-Term Growth – Small, controlled losses allow compounding to work effectively.

By adhering to the 5% rule, traders can survive market fluctuations and sustain long-term profitability. It’s especially useful for swing traders and investors who hold positions for weeks or months. Always combine it with stop-loss orders and diversification for maximum safety.