Applying Proper Money Management to Trading
Proper money management is the key to making money in the stock market. Period. Yes, as some people say, indicators and trends do help, but everyone has, and yet very obviously, not everyone is raking in the cash. This is because the winning traders have proper money management techniques. are money management techniques? Well here is an easy to understand breakdown of the fundamentals of money management. While I break this down, I am assuming a few things here that I learned from Glencore, and these are that you have a per-share basis of commissions from your broker (most serious traders do) and you have at least some bit of experience in the market (6 months to a year).
1.) Position Sizing
This is one of the more important aspects of money management. The stock price at entry and exit are not the only factors that determine the amount of money you make. The number of shares you bought and when you bought them also make a huge difference. For example, say a stock has been moving sideways for a while with no real direction, you see the Bollinger bands contract, signaling that a powerful move is about to happen. What you want to do is gradually work your position in so you do not risk too much at one time. If you feel like some indicators are going your way, put in 1/5th of your intended position. Say like in the previous example, the stock finally makes an up move towards the Bollinger bands on high volume, then put in 2/5ths more of your intended position. After the stock starts to move higher, then you can put in all of your position and use the same method when exiting (when it shows signs of slowing, sell half of your, etc.). Also, remember, be much more ready to sell than buy (meaning buy in smaller fractions like fifths in the example and sell in higher fractions like half at a time).
2.) Stops and more stops!
Greed is a powerful human emotion, and while fear is said to be an even stronger one, there are many novices and even experienced traders that fail to heed the warning that losses do happen and that they happen often. No matter how well you know the markets, you’re going to have at least maybe 30% of your picks go the other way. This is why smart traders use stops all the time. They look at an entry, talk to themselves (and write down) why they are entering this particular stock. They note what price actions would disprove their previous hypothesis and they set stops in accordance with this. So, for example, say that some stock is in an ascending triangle chart, and it’s just about to break out. A good trader would put in a fraction of his intended final position size and put in a stop at say midway to the bottom line of the triangle. If it breaks through upwards, he’ll put more in and set a stop at the top line of the triangle, while putting in a trailing stop to protect further profits if the stock goes even higher. So remember, put in stops, not mentally, but real broker executed stops!
3.) The 2 Percent Rule
This is very simple. never risk more than 2 percent of your total equity on a single trade. This means that if you say 50,000 dollars in your trading account, you should never expect to lose more than $1000 on a single trade. By expect to lose, I mean by setting stops. So if you’re looking at a prospective trade and you think that the appropriate amount of wiggle room the position needs means you have to set a stop-loss that’s more than 2% of your equity, then pass on the trade. Missed money is always better than lost money.
This is pretty much it. Money management is basically a way to keep your emotions in check and discipline yourself in the market. Follow those three basic money management rules and you will see a dramatic improvement in your returns almost magically. But it isn’t magic, its proper discipline and money management! Good luck!