3-5-7 rule in stocks: Smart trading is not only about making profits but also about managing risks effectively. All trades are accompanied by risk, and
what may look like an attractive trade could turn out to be expensive if there is not enough planning in place. Here is where the 3-5-7 Rule is applicable. Think of it as a safety net built right into your trades, an easy-to-remember yet potent rule of thumb in which to guide your decision-making. With the 3-5-7 rule, you set guidelines in place to limit your risk exposure on any individual trade, in the market as a whole, or in your overall investment portfolio. In this article, we will walk you through exactly what you need to know, including how it works, why it is effective, and how you can incorporate it into a trading plan of your own that keeps risk under control. Further, we'll also examine examples to ensure that you are able to trade more confidently and disciplined, and have a plan in place to keep risk under control.
What is the 3 5 7 rule?
The 3-5-7 Rule is an effective risk management technique in trading, and it is quite simplistic in its application. Based on this technique, there are three major concepts to keep in mind.
First, it states that no trade should ever be placed with more than 3 per cent of the total capital used in trading. Then, total exposure on all open positions should never exceed 5 per cent of the total capital. Lastly, ensure your winning trades are at least 7 per cent more profitable than your losing trades.
Breaking down 3-5-7 rule: ‘3' in 3 5 7 rule
The first part of the rule, 3 per cent per trade, helps protect your capital. It means that no single trade should risk more than 3 per cent of your total trading balance. This prevents a single bad trade from significantly impacting your portfolio.
By sticking to this limit, you stay disciplined and make calculated decisions rather than emotional ones. It encourages you to carefully analyze each trade, weighing both risk and reward before committing your money.
3 per cent Example: If your trading account has Rs 10,00,000, the 3 per cent rule means that the maximum loss on any single trade should not exceed Rs 30,000.
Breaking down 3-5-7 rule: ‘5' in 3 5 7 rule
The second part, 5 per cent total exposure, ensures you don’t overcommit to a single market. This means that across all your open trades, your total exposure should not exceed 5 per cent of your total trading capital.
This approach encourages diversification, reducing the risk of major losses if one trade or market performs poorly. It also motivates traders to explore different asset classes or industries, creating a more balanced portfolio.
5 per cent Example: In a portfolio worth Rs 50,00,000, according to the 5 per cent rule, no more than Rs 2,50,000 should be invested in a single market or asset class.
Breaking down 3-5-7 rule: ‘7' in 3 5 7 rule
The final part, a 7 per cent profit target, focuses on ensuring that your winning trades are significantly more profitable than your losses. This means aiming for at least a 7 per cent gain on successful trades, so that your wins outweigh the inevitable losses.
By setting this goal, you naturally prioritize high-probability trades and avoid low-quality setups. Over time, this approach improves overall profitability by making sure your best trades bring in more than what you lose on unsuccessful ones.
7 per cent Example: To follow the 7 per cent profit target, if a trader has Rs 1,00,00,000 in their account, they should aim for a maximum exposure of Rs 7,00,000 on a single trade to keep risk and reward balanced.
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(Disclaimer: The above article is meant for informational purposes only, and should not be considered as any investment advice. ET NOW DIGITAL suggests its readers/audience to consult their financial advisors before making any money related decisions.)
