Money Management

"The most important thing is money management, money management, money management. Anybody who is successful will tell you the same thing."
Marty Schwartz - one of the most successful traders of our time.

You shall surely fail if you ignore the money management rule laid out in this section.

Many traders are anxious to start trading. They jump right in. They simply determine how much they can afford to lose in a single trade and click buy or sell. They ignore the need to manage their money.

When you trade without money management rules, you are in fact gambling. You are not looking at the long term return on your investment. Instead, you are only looking to make a killing. Money management rules not only protect us, but they make us very profitable in the long run.

Money Management Rule: Never risk more than 2% of your capital on any single trade.

No matter how successful your strategy, you will eventually encounter a losing streak. This is something most successful traders agree on.

A strategy that is, say, 80% profitable should generate 80 winning trades out of every 100 trades. But such a 'successful' strategy used without proper money management could turn you into a loser.

80% profitability does not necessarily mean that for every 100 trades you make, you will win 8 out of every 10. You have no way of knowing which 80 of those 100 trades will be winners. It is possible that you could lose the first 20 trades in a row and win the next 80.

But could you sustain such a losing streak? Could you afford to lose 20 trades in a row? Would you still be trading? Your confidence most likely shattered, you just might give up trading altogether . only to miss a possible winning streak of 80 trades.

Top traders practice money management because they know they will not win every trade. They only risk a small percentage of their capital so that they can survive those losing streaks.

The 2% rule will ensure that you survive your losing streaks.

Let us illustrate what happens when you risk a small percentage (2%) of your capital compared to risking a higher percentage (15%).

 

Trade # Total Account 2% risk per trade 1 $15,000 $300 2 $14,700 $294 3 $14,406 $288 4 $14,118 $282 5 $13,836 $277 6 $13,559 $271 7 $13,288 $266 8 $13,022 $260 9 $12,761 $255 10 $12,506 $250 11 $12,256 $245 12 $12,011 $240 13 $11,771 $235 14 $11,535 $231 15 $11,305 $226 16 $11,079 $222 17 $10,857 $217 18 $10,640 $213 19 $10,427 $209

Trade # Total Account 15% risk per trade 1 $10,000 $1,500 2 $8,500 $1,275 3 $7,225 $1,084 4 $6,141 $921 5 $5,220 $783 6 $4,437 $666 7 $3,771 $566 8 $3,206 $481 9 $2,725 $409 10 $2,316 $347 11 $1,969 $295 12 $1,673 $251 13 $1,422 $213 14 $1,209 $181 15 $1,028 $154 16 $874 $131 17 $743 $111 18 $631 $95 19 $536 $80

 

As you can see, there is a big difference between risking 2% of your account on a single trade compared to risking 15%.

If you lost 10 trades in a row, and you risked 15% on each trade, your $15,000 investment would have dwindled to just $2,316. You would have lost over 85% of your account!

But if you risked only 2%, after 10 losing trades you would still be left with $12,506. This is only a 17% loss of your total account.

Look at the difference between risking 2% and 15% if you only lost 5 trades in a row. If you risked 2% you would still have $13,836 left. If you risked 15% you would only have $5,220 left. That's less than the amount you would be left with had you lost all 10 trades and risked only 2% of your account.

The lesson here is that you want to observe the money management rules so that when you do have a drawdown period (losing streak) you will still have enough capital to continue trading.

This table illustrates what percentage you would have to make to breakeven if you were to lose a certain percentage of your account.

You can see that the more you lose, the harder it is to make it back to your original account size. This is all the more reason you should do everything you can to protect your account.

So, never risk more than 2% of your capital on any single trade. This will ensure that you survive your losing streaks and still be around to capture the winning trades.


Another Crucial Rule Never allow the result of any single trade to disrupt or change your strategy.

It's a natural human tendency to lose confidence and stray from the game plan when you lose a trade.

Bill Lipschutz, the Sultan of Currencies - for eight years Salomon Brothers largest and most successful forex trader - had this to say:

"When you're in a losing streak, your ability to properly assimilate and analyze information starts to become distorted because of the impairment of the confidence factor, which is a by-product of a losing streak. You have to work very hard to restore that confidence."

If you have a strategy that has proven successful, you should stick with it. If you give up when you lose a few trades, you will miss out on profitable trading opportunities waiting around the corner.

So . stick with the strategy.