Money Management - Performing It Good
Money Management - Performing It Good
Money Management - Performing It Good
However the better cash management system in the world is not going to help unless you have a successful trading method. Understanding money management methods will help in creating the successful trading method you use and can increase profits by reducing unnecessary risk. Once you notice that a stop loss must always be in place then position sizing can become a fact the final goal with money management is to create a smooth equity curve.
So what's with the money thing? What's the secret?
You just need to sort out what's just for you within a mathematical framework.
There are different models you can use from any of the three wise men quoted above, and, there are others such as Van Tharp (Ryan Jones is also an expert but he seems to accommodate larger draw downs and Ralf Vince who can get a little complicated). You can catch Van Tharp later this year in Melbourne and Sydney.
The beautiful thing about money management is that mathematics doesn't lie. Excellent money management breaks down your trading into mathematical units so you can identify your strengths and weaknesses in your trading. You will need to make your weaknesses your strengths or failure will follow.
Keeping it simple - the "2% rule"
Only risk 2% of your total capital per trade! Some say that's too much and others say that's too little.(if you would like more info on the 2% rule and leverage please email me) 2% is a so starting point for risk if you are having 50% success with your trades, if not use 0.05% - 1.00%
Quick example
Account Size: 10,000
WSA Trading at $2.20
Stop Loss at 1.95
The difference equals risk = $0.25 cents
Risk 2% of Total Acct: 10,000
Equals = $200.00
$200.00 divides $0.25 = 800 shares
Total Risk $200.00
To try a little more advanced management model use Van Tharp's model to work out what he calls his 'R Multiple'. R simply means Risk, the risk you're willing to give a trade.
If say your dollar risk on your first trade is $200 then that is equal to 1R, if you lose your risk capital i.e. the $200, then you need to express that as a negative -1R. If you created a profit of $200 then you express that as positive 1R, If you created $300 profit then it would be expressed as 1.5R and a $400 profit expressed as 2R and so on, the same for larger losses. Let's say after 20 trades, you need to add up all the positive R's and subtract the entire negative -R's. Once you have the balance expressed in R multiples, lets say 15 R you can then use this figure to work out your Expectancy, that is, your future earning per dollar invested. To get the Expectancy you need to divide your R Multiple into the amount of trades, in this case 20 trades. Divide 15R into 20 trades = 0.75 Expectancy. This will tell you how good your system is.
When to risk more
Let's call your current trading capital Base Capital, and you only ever risk 2% of that. But you wish to take higher risks now. Well then you can risk more only on your current profits, profits that have not been returned to your Base Capital as yet. As Base Capital rules only allow you 2% risk. So what percentage of current profits should I risk?
One logical way of doing this is to divide your expectancy into your R multiple e.g. 0.75 divide 15R = 5%.
So at this stage Risking 2% of Base Capital, and risking 5% of profits. The question of when to return your profits to Base Capital could be from time, percentage, dollar value or goals achieved etc.
There are further aspects including: smoothing out your equity curve; and, scaling into and out of positions at break even points with 2% risk; both of which would enhance your money management model.
Fundamentally trading accounts are lost because of large losses/over exposure and are not of the 0.5 -2% risk management ratio.
Once you encounter a trading plan that suits your personality, you will need to put it to the test, experimenting and practicing with a risk percentage of half of one percent is the norm. A good mentor would make you practice until you could prove that you have all aspects under control. Establishing the discipline to have a stop on all trades in the derivatives market is imperative, followed by position sizing.
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