Money Management (The Keys To The Kingdom)

The creation of a speculator's wealth comes from how he manages his money, not some magical, mysterious system or alchemist's secret. Successful investing makes money; successful investing with proper money management can create immense wealth.
- Larry Williams

Why is it that two people can trade the same market and have the same entry points, yet one person does quite well while the other person blows out his or her account? The answer is money management. Money management is a skill that must be mastered if one wishes to do well in the markets. Everyone is always concentrating on finding the holy grail or finding a system that is 90% accurate but what they fail to realize is that all we need is a small edge in the market. We don't need to be right all the time. All we need is to have some small advantage, combine that with good money management and a person will be able to take profits out of the market over time.

When I say money management, what I am talking about is how much a trader is willing to risk on each trade and how they manage the trade once a position is taken. There are many approaches as to how much we should risk on a trade, some of them are: Fixed Ratio (Ryan Jones), The Kelly Formula, Optimal F by Ralph Vince..etc.. I think the easiest way to manage your money is to risk a certain percentage of your account on every trade that you are comfortable with.

I like to risk about 5% on every trade..So lets say I have $100,000 in my account. I will risk about 5k on a trade.. As the account grows that 5% number will grow too allowing me to trade larger. As the account loses money (which I am very familiar with) that 5% figure will also get smaller allowing me to stay in the game and not blow up. What most people do when they lose money is they will risk more than 5% and when they lose, they lose a huge percentage of their account. In a matter of months they will no longer be trading. So by sticking to the 5% rule you will do just fine. If you don't have the stomach for 5%, then risk only 2% but be consistant. Always risk the same percentage on every trade.

Besides how much we should risk on each trade, we have to also know how to manage a trade once we are in a position. We really should only take trades that have a risk reward of at least 3 to 1. Our profit objectives should be at least 3 times as large as our risk. That's the goal we should be striving for. Letting profits run and cutting losses short is so important that if you don't do it, you're not going to last very long. We must have those big wins to offset all those losers and the only way to do that is to let the profitable trades develop while cutting the losers short.

From my own personal experience, I've always been focused on the entry into a position because I thought the entry into a trade is everything. What I've learned over the years is that the exit is what is most important not the entry. The exit is everything. The exit will determine how much money you make or lose so doesn't it make sense to focus on exiting trades as best you can? It took me years to realize this but once you get good at your exits and how much to risk on a trade, your trading account will begin to grow in a way you have never seen before with much less stress too. We'll talk more about this in future posts because I can't say enough about managing your money and managing your trade.