Money
Management
Money
Management is the key to long term survival and prosperity in
trading.
Poor money management is responsible for the failure of many traders.
You can have a good trade selection method and still lose money
if you don't follow sound money management rules.
Money management is designed to preserve capital if your trading
is not going well and to capitalise on winning trades and improve
your overall profitability.
In its basic form, money management
is maintaining your capital and then profiting from cutting your
losses short and letting your profits run.
More than ever money management is important.
Part
1: Asset Allocation
There
are two types of risk to consider when investing or trading: monetary
and technical risk.
-
Monetary
risk is the amount of money you can risk on each
trade.
-
Technical
risk is the price that is determined by your technical
indicators. This is covered in our trading rules.
There
are 3 ways to determine the amount of your capital to allocate
to a trade and determine your overall risk.
-
Use
a set trade size and determine if the risk on the individual
trade is acceptable. This strategy is mostly used
by people trading futures, options, etc, where the trades
are carried out in contracts. You determine the percentage
or dollar amount you can risk on the trade and if the technical
risk is within this limit, then you can place the trade.
-
Fixed
fractional trade size. With a fixed fractional strategy
you have a set percentage of your trading account that you
will risk on each trade. Your trade size is determined by
the set amount you are prepared to risk on each trade. E.g.
the trade size is calculated by dividing the risk amount per
trade with the technical risk of that trade. In volatile markets
when the technical risk is large, the trade size will be small.
In quiet markets when the technical risk is low, the trade
size will be larger. Your risk should not be greater than
2% per trade. This allows you to have a number of losses without
greatly affecting your overall account value.
-
Variable
fractional trade size. This is the same as fixed
fraction trade size except you reduce the risk amount after
losing trades
For example: Risk 2% on first trade. If that trade is a losing
trade then only risk 1.5% on the next trade. If that trade
is a losing trade then only risk 1% on the next trade. If
that trade is a losing trade then only risk .5% on the following
trades. Stop trading when you have had 6 losing trades in
a row and evaluate your trading strategy and your application
of it. I have found that in most cases, it is the application
of the trading rules that is the problem, not the trading
system. Go over your trades and determine: 1) Have you followed
your trading rules? 2) Has the market changed character? Or
3) Does your trading strategy work in the real market?
