In my last post, I went over money management issues when building a solid trading strategy. If you did not see the post, you can read it here: Deciding Trading Strategy Money Management
Money management is such an important part of your trading system, I thought I would go over some other concerns. There is much more to proper money management than just picking a lot size. As a matter of fact, it is a synergistic relationship between many aspects of your trading system working together and your trading personality.
Here is what I mean…
These are some of the things that need to work together in order for your to have good money management:
- Your stop loss size
- Your take profit targets
- Your win/loss ratio
- Your risk/reward ratio
- How many trades you take on an account
- Your trading personality (More on this below)
All these things need to be working in alignment so you can safely grow your account. Money management is really RISK management and should be approached by focusing on the worst case scenario.
What would happen to my trading system during a losing streak?
I know, it is a lot more exciting to focus on how much money you can make. But if you are not prepared for an eventual losing streak, poor money management can quickly eat up your account. But if you only focus on preventing loss, you are going to end up sacrificing gains. And therein lies the problem.
You need to walk a tightrope with your money management so the gains fulfill your GREED and your losses don’t trigger your FEAR.
Money Management In Terms Of Greed And Fear
You’ve probably heard you need to keep emotions like greed and fear out of your trading. Unfortunately, I think this is impossible. In reality, you need to learn to live with the emotions of greed and fear, and that has a lot to do with aligning your money management with your trading personality.
Fulfillment Of Greed
Let’s say you have a $10,000 account and only want to trade 0.01 lots per trade with a 50 pip stop loss and 75 pip take profit. This is a very conservative money management strategy. Yes, you would not be risking too much on your trades, but would you be satisfied with the gains? Would you be able to trade like this long term and fulfill your trading goals?
In the end, you need a money management strategy in place that has the potential to fulfill your trading and financial goals. Otherwise, you are not going to feel satisfied with the efforts you put into your trading. This can lead to abandoning trading all together, or implementing risky trading practices to look for the profits you are missing.
Avoidance Of Fear
So, you want a money management strategy that can fulfill your economic goals, but you don’t want to be kept up at night. Any time you place a trade and put real money at risk there is a certain amount of excitement. (Even if you are using an expert advisor to place and manage your trades, you still are emotionally invested in the trading when you look at your account and the results).
However, every trade you place can not be “do-or-die”. Trading is a long term activity and you’ll never last if you are overstressed by each trade you place. You need to be able to handle the trading emotionally by not risking too much on any one trade. Essentially, you need to find a level of fear you can live with.
As you can see, the money management strategy you use is a compromise between wanting to make as much money as possible and not putting your money unnecessarily at risk to the point you cannot sleep at night.
Every trader is different. There is not ONE money management strategy that is right for everyone. This is a personal choice you will have to make for yourselves.
I will say this though…
In my experience with would-be traders, I find most people tend to set their trading goals extremely high. They are either looking for an extremely high win rate, or the ability to make large percentage gains each month on a consistent basis. These goals usually lead to using risky trading and money management techniques.
In order to align your money management with your trading personality, you need to first take a look at your trading personality. Are your goals realistic and achievable?
In most cases, I think it is necessary to lower your expectations for trading and work on using a money management strategy to achieve these lowered goals. (You’d be surprised how much following this one bit of advice can increase your chances of trading success).
In keeping with the money management theme, I want to talk next time about win/loss ratio versus risk/reward ratio. In the meantime, leave comments about money management in terms of greed and fear. Have you ever thought of money management in these terms before?