What Everybody Ought to Know About Money Management

November 14, 2006 by Trader Rich

OK, so I'll admit that I'm using a catchy headline to force people to enhance their knowledge on the all important subject of Money Management.

I went to Borders yesterday to search for some literature on money management and found a majority of trading books having only one or two pages on the subject. I couldn't find a book dedicated to the subject, though I know there are several out there. One book I spent some time reading had a pretty large money management section. It was called "High Probability Trading" by Marcel Link. I didn't take notes though so I already forgot a lot of what I read. One thing I was able to take away from the book was the comparison between you as a trader and a casino. As a trader, you would benefit most by acting like a casino. The casino has established rules for their games that provide them with an edge. For example, with most bets in the game of roulette, the house has an edge of 5.26%. They are not concerned with any one person winning unless this person compromises this edge like counting cards. They are more concerned about all gamblers as a whole. The casino expects that in the long run, of all the money bet on the roulette wheel, they will come out on top 5.26%. I'm sure in most cases, it's a lot more. As a trader, money management isn't quite good enough if you don't have a system with some sort of edge. The bigger the edge, the better.

There is an excellent website on money management that I had talked about in a previous post months ago. The content isn't presented all that great though. Information is scattered and there are sections where the presenter just copies and pastes certain content relevant to the subject. Nevertheless, it is the best site I've seen out there that's dedicated to money management and I'll attempt to summarize the important points starting from the first section.

Source: http://members.aon.at/tips/moneyMan1.htm

"We cannot influence how the markets will behave, (therefore) we should
at least exercise control over those variables that we have actual
control of." This is where money management comes into the picture.

Q & A

Q. What is the difference between risk management and money management?

A. Risk management deals mainly with maximizing profits using
contract sizes. Money management deals mainly with minimizing losses
using stops as well as showing you when to take profits. You must have
both.

Q. What is the Percent Risk Model?

A. Simply, it is using a certain percentage of your capital for position sizing.

Q. What is constant risk?

A.
Adjusting your stops according to your system and peel off (reduce)
contracts when the risk got above the level you wanted to maintain.

Q. What is Market Wizard "money management" rule?

A. Always risk exactly 2.6% of total (closed + open) account equity on every trade

TIPS FOR FAILURE

Trading 1 contract at a time will cause you to fail.

TIPS FOR SUCCESS

The key is to have more positions when you are right and less positions when you are wrong.
Stagger out of your trades when wrong or put another way, stagger your stop losses
Hold on to all positions when right
Never let a winner become a loser by adjusting your stops as the market moves with you
Know
the Pareto Principle, also known as the 80-20 rule which when applied
to trading states that 80% of your profits comes from 20% of your trades
Stay with all of your positions until they meet the minimum profit objective
Exit a portion of your trade at the minimum profit objective.
Hold the rest using a trailing stop to take advantage of huge trenders
Remain unbiased or without opinion as to the market direction.
Realize there is no such thing as overbought/oversold and no price is
too high or too low.
Like your losses because losing is a big part of trading and it also puts you one step closer to a winning trade
Visualize what you want to accomplish before getting there

"We cannot influence how the markets will behave, (therefore) we should at least exercise control over those variables that we have actual control of." This is where money management comes into the picture.