Let’s talk about one of the three Ms of trading – Money Managment.
Many people will use the term risk management however I believe the two terms are basically the same. Risk is the likelihood of something adverse occuring. When something adverse occurs in trading, guess what it affects? Our money!
In other words, when we are managing risk, we are indirectly managing our money.
Notwithstanding the importance of your trading mindset, your money management will make or break you as a trader.
Despite what goals you might set yourself with your trading – there is a constant. Every trader should have the same primary goal. Every action you take should have this goal in mind.
Your primary goal in trading is to … Preserve Your Capital
Nothing is more important.
This presents a problem for most people. Let’s think about it … why do we trade? For most of us (and let’s be honest about this), we trade for the money! As Rod Tidwell (played by Cuba Gooding Jr.) said in the movie Jerry Maguire, “Show Me the Money!”
This is why we trade yet our primary goal isn’t to make money – yes, it is important, however it is not as important as looking after the money you have to trade with.
No more money – no more trading! Simple …
So what do we do in order to manage our money? There are a number of vital things (albeit simple) you must have in place in order to manage your money effectively.
The two main areas with money management are setting stops and capital allocation – in other words, for each trade, how much of our capital do we commit.
Let’s briefly look at these two areas.
You are going to have many occasions when you open a position and it moves in the opposite direction to what you had anticipated. A key issue as a trader is to realise and accept that losses are a normal part of trading.
To put this into perspective, the outcome of every trade is dependent on the exit. If you enter in a timely manner and then exit poorly, the trade could very easily be a loss. If your entry happens to be poor but your exit is good, you might actually still salvage a profit, or at the worst, minimise a loss. The exits, and not the entries, determine the outcome of your trades.
We can obviously either exit at a loss or in profit. To cut losses, we use stop losses and to let profits run, we use trailing exits.
So far as capital allocation is concerned, a common term used to describe this is position sizing. This answers the question of how many shares you are buying, how many contracts you are selling etc. Position sizing is one of the most important parts of money management.
Money Management is one of the foundations of trading well. Remember, if you lose your trading money – no more trading. Of all the mindset problems we face, most of them come back to this area – managing our money. As people, money tears at our emotions in ways that little else can.
Therein lies the key. If you want to achieve trading success, you need to manage your risk (and indirectly your money). However, the problem is that to manage your risk goes against all the things we naturally want to do as people.
Often, we don’t want to cut losses and we do want to commit a lot of money to a trade that we feel superconfident about. In other words, to manage your money well, you need to be disciplined – this is how your mindset and money management are linked together.
By having your mind tuned into the trader’s mindset, you will be disciplined and committed to making all the right decisions. Have confidence in yourself and make it happen! It is a key to profitable trading.
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I have written detailed market commentary of equities, foreign exchange, indices and commodities for several leading brokerages around the world. I offer detailed technical analysis providing a real traders perspective on price action, trends and key levels in order to assist clients make more informed decisions.