It used to puzzle me why institutional traders as a group performed so much better than private traders. An average private trader is a 50year-old married, college-educated man, often a business owner or a professional. You would think this thoughtful, computer-literate, bookreading individual would run circles around some loud 25-year-old with minimal training who used to play ball in college and hasn't read a book since his junior year. In fact, the lifetime of most private traders is measured in months, while institutional traders continue to make money for their firms year after year. Is it because of their fast reflexes? Not really, because young private traders wash out just as fast as older ones. Nor do institutional traders win because of training, which is skimpy in most firms.

Institutional traders who make a lot of money sometimes decide to go out on their own. They quit the firm, lease the same gear, trade the same system, stay in touch with their contacts-and fail. A few months later, most cowboys are back in head-hunters' offices, looking for a trading job. How come they make money for the firms but not for themselves?

When an institutional trader quits his firm, he leaves behind his manager, the person in charge of discipline and risk control. That manager sets the maximum risk per trade for each trader. That is similar to what a private trader can do with the 2% Rule. Firms operate from huge capital bases, and the risk limit is much higher in dollar terms but tiny in percentage terms. A trader who violates that limit is fired. A private trader can break the 2% Rule and hide it, but a manager watches his traders like a hawk. A private trader can throw confirmation slips in a shoebox, but a trading manager quickly gets rid of impulsive people. He saves institutional traders from disastrous losses, which destroy many private accounts.

In addition, a trading manager sets the maximum allowed monthly drawdown for each trader. When an employee sinks to that level, his trading privileges are suspended for the rest of the month. We all go through cycles. Sometimes we're in gear with the markets, and every thing we touch turns to gold. At other times we are out of sync, and everything we touch turns into a completely different substance. You may think you're hot, but when you keep losing, it is the market's way of saying you're cold.

Most private traders on a losing streak keep trying to trade their way out of a hole. A loser thinks a successful trade is just around the corner, and that his luck is about to turn. He keeps putting on more trades and increases his size, all the while digging himself a deeper hole in the ice. The sensible thing to do would be to reduce your trading size and then stop and review your system. A trading manager breaks his traders' losing streaks by forcing them to stop after they reach their monthly loss limit. Imagine being in a room with co-workers who are actively trading, while you sharpen pencils and run out for sandwiches. Traders do all in their power to avoid being in that spot. This social pressure creates a serious incentive not to lose. A friend who used to manage a trading department in London had a woman on his team who was a very good trader. Once, she hit a losing streak and by the middle of the month was nearing her loss limit. My friend knew he would have to suspend her trading privileges, but she was very high-strung and he did not want to hurt her feelings. He found a course on treasury management in Washington, DC, and sent her there for the rest of the month. Most managers are not so gentle. Gentle or rough, the monthly loss limit saves traders from death by piranha bites- a nasty series of small losses that can add up to a disaster. The piranha is a tropical river fish, not much bigger than a man's hand, but with a mean set of teeth. It doesn't look very dangerous, but if a dog, a person, or a donkey stumbles into a tropical stream, a pack of piranhas can attack him with such a mass of bites that the victim collapses. A bull can walk into a river, get attacked by piranhas, and a few minutes later only its skeleton will be bobbing in the water. A trader keeps sharks at bay with the 2% Rule, but he still needs protection from the piranhas. The 6% Rule will save you from being nibbled to death.

Whenever the value of your account dips 6% below its closing value at the end of last month, stop trading for the rest of this month.

Calculate your equity each day, including cash, cash equivalents, and current market value of all open positions in your account. Stop trading as soon as your equity dips 6% below where it stood on the last day of the previous month. Close all positions that may still be open and spend the rest of that month on the sidelines. Continue to moni-tor the markets, keep track of your favorite stocks and indicators, and paper trade if you wish. Review your trading system. Was this losing streak just a fluke or did it expose a flaw in your system?

People who leave institutions know how to trade, but their disci pline is external, not internal. They quickly lose money without their managers. Private traders have no managers. This is why you need your own system of discipline. The 2% Rule will save you from a dis astrous loss, while the 6% Rule will save you from a series of losses. The 6% Rule forces you to do something most people cannot do on their own-stop losing streaks.

Using the 6% Rule, along with the 2% Rule, is like having your own trading manager. Let us review an example of trading using these rules.

For simplicity's sake, let us assume we'll risk 2% of equity on any given trade, even though in reality we try to risk less.

At the end of the month, a trader calculates his equity and finds that he has $100,000 and no open positions. He writes down his maximum risk levels for the month ahead: 2% or $2,000 per trade and 6% or $6,000 for the account as a whole.

Several days later the trader sees a very attractive stock, A, figures out where to put his stop, and buys a position that puts $2,000, or 2% of his equity, at risk.

A few days later he sees stock B and puts on a similar trade, risking another $2,000.

By the end of the week he sees stock C and buys it, risking another $2,000. The next week he sees stock D, which is more attractive than any of the three above. Should he buy it? No, because his account is already exposed to 6% risk. He has three open trades, risking 2% on each, and he may lose 6% if the market goes against him. The 6% Rule prohibits him from risking any more at this time.

A few days later, stock A rallies and the trader moves his stop above breakeven. Stock D, which he was not allowed to trade just a few days ago, still looks very attractive. May he buy it now? Yes, he may, because his current risk is only 4% of his account. He is risking 2% in stock B and another 2% in stock C, but nothing in stock A, because its stop is above breakeven. The trader buys stock D, risking another $2,000, or 2%. Later in the week, the trader sees stock E, and it looks very bullish. May he buy it? Not according to the 6% Rule, because his account is already exposed to a 6% risk in stocks B, C, and D (he is no longer risking any equity in stock A). He must pass up stock E.

A few days later stock B falls and hits its stop. Stock E still looks attractive. May he buy it? No, since he already lost 2% on stock B and has a 4% exposure to risk in stocks C and D. Adding another position at this time would expose him to more than 6% risk per month.

The 6% Rule protects you from the piranhas. When they start biting you, get out of the water, and do not let the nasty fish nibble you to death. You may have more than three positions at once if you risk less than 2% per trade. If you risk only 1% of your account equity, you may open six positions before maxing out at the 6% limit. The 6% Rule protects your equity, based on last month's closing value and not taking into account any additional profits you may have made this month.

If you come into a new month with a big open profit, you have to re-calibrate your stops and sizes so that no more than 2% of your new total equity level is exposed to risk on any given trade and no more than 6% on all open trades combined. Whenever you do well and the value of your account rises by the end of the month, the 6% Rule will allow you to trade a bigger size the following month. If you do poorly and the size of your account shrinks, it will reduce your trading size the next month.

The 6% Rule encourages you to increase your size when you're on a winning streak and stop trading early in a losing streak. If the markets move in your favor, you will move your stops beyond breakeven and put on more positions. If your stocks or futures start going against you and hitting stops, you will lose your maximum permitted amount for the month and stop, saving the bulk of your account to trade the next month.

The 2% Rule and the 6% Rule provide guidelines for pyramiding- adding to winning positions. If you buy a stock, it rises, and you move the stop above breakeven, then you may buy more of the same stock, as long as the risk on the new position is no more than 2% of your account equity and your total account risk is less than 6%. Handle each addition as a separate trade.

Most traders go through emotional swings, feeling elated at the highs and gloomy at the lows. If you want to be a disciplined trader, the 2% and the 6% Rules will convert your good intentions into the reality of safer trading.