Many experienced fund managers and traders consider money management the keys to the kingdom. Quantifying swing trade ideas and allocating the correct amount of capital can immediately improve your results before you ever hit the buy button.
Money management is often lumped together with risk management. Instead we should consider them two separate steps to a complete trade. Successful traders eliminate random or unplanned trades and therefore reduce unnecessary risk prior to the trade.
It’s said the true risk in a trade is the quality of the idea. I believe this to be correct.
Money Management Defined
At its core, money management is the amount of capital you plan to allocate to a swing trading idea. Risk management is how you manage the trade. So risk management is closer related to trade management.
Many educators will teach a blanket percentage of capital should be applied to every trade. Depending on your experience and risk tolerance 2-5% is a standard recommendation. I can tell you this sounds good on paper, but it is only correct if every trade had identical probabilities for profit. They don’t.
Simply stated some trades have better odds than others. Each trade is unique and requires an assessment of the risk/reward potential.
You must ask:
- “How much risk is required for the potential profit?”
- “What are the odds of the profit target being reached versus the stop-loss? In other words what are the odds of follow through?”
Consistent traders know when the odds are in their favor and will allocate money accordingly. They know the probabilities of each trade and are disciplined to make smart decisions. Great money managers are risk averse and do not make trades that do not have a positive expectancy.
Proper Money Management Mindset for Losing Trades
Professional traders don’t mind losing trades as long as the odds made sense. Losing is part of successful trading as long as you lost money on a quality idea. Amateurs attempt to make back big losing trades quickly.
This is poor decision making. They are trying to force an outcome which results in accepting risk for future trades outside of planned criteria.
The best traders will immediately get back into a long-term mindset and forget “revenge trading.” A long-term mindset means you are assessing each trade individually but allowing your edge to play out over many samples.
This is trading at its finest and not many do it correctly. Emotions can wreak havoc on the best plans.
The Power of Money Management
You can have a great system with a solid edge and yet lose money with poor money management. Yet, a mediocre system with disciplined money allocation skills can produce consistent performance.
Money Management Goals
Good money management is designed to keep you in the game. To keep you in the business after a bad hit or a series of poor results. Notice I didn’t say bad trading. You can trade perfectly and still have a streak of losing trades. Amateurs don’t understand this which is why too many of them tweak their system to death never truly giving it a chance to work.
Your number one goal is preserve capital while you step in the line of fire. You can’t earn profits without taking and accepting risk. A well-thought-out money management plan gives you the best chance to succeed.
Your plans need to be tailored to your goals and resources. Are you nervous Nellie or rick taking Randy? Determine for yourself a baseline of risk per trade, and then adjust it up or down on your perceived probability of the scenario. If the risk reward makes sense make the trade. If both pieces don’t fit, it is OK to let the trade go.by