Money Management

There are three key elements to being a successful trader.
1. Money Management
2. Market Analysis and A Good Trading System &
3. Sound Personal Psychology
We will cover all three of these in this course. Each of these three key elements are
equally important and without all three you will not succeed as a trader. Borrowing an
analogy from Dr. Alexander Elder, a respected psychiatrist and professional trader, in his
book Trading for A Living he says These three essentials are like three legs of a stool
remove one and the stool with fall, together with the person that sits on it. Losers try to
build a stool with only one leg, or two at the most. They usually focus exclusively on
trading systems. This chapter covers the first of the three, money management.
Trading without proper money management is like trying to cross a desert with no water -
you won t make it. As traders, our first goal of money management is to insure survival.
The second goal is to generate a steady rate of return, and the third goal is to make a high
rate of return, survival however, is the first.
NEVER RISK YOUR WHOLE ACCOUNT on one trade is your very first rule of
trading. People who lose money frequently violate it by risking too much of their account
on a single trade. They continue trading the same or even bigger sizes during a losing
streak. Most losers get killed trying to trade their way out of a hole. Luckily, good money
management can keep you out of the whole in the first place.
Let me illustrate how the more money you lose the more difficult it becomes to try to
earn it back. If you have a $10,000 account and you lose 10 percent, ($1000 of your
account), you have to make 11 percent on the account which is now $9000 to recoup that
loss. If you lose 20 percent ($2000) you need to make 25 percent on what is now $8000
to come back. If you lose 40 percent ($4000), you need to make a whopping 67 percent
of what is now $6000, and if you lose 50 percent of your account which would make it
$5000 you need to make 100 percent just to recover your money. While losses grow
mathematically, the profits that are required to recoup them increase almost
exponentially.
This is why it is absolutely crucial never to let these kinds of losses occur, and the only
way to do this is to employ and adhere to strict rules of money management. Amateurs
often ask what percent profit they can make per week, per month, or per year trading
currencies. The answer to that question depends on their skills (or lack of skills) as a
trader, the quality of their trading system, and market conditions. Amateurs however
never ask a more important question: What can I do to insure that I do not lose my
money? You must be sure you are not going to lose your money before you worry abouthow much you are going to make. Proper money management is your best insurance
policy on your trading capital.
HOW MUCH TO RISK
Most traders get wiped out by one of two things, ignorance or emotion. Amateurs act on
hunches and spontaneous urges to stumble into trades they never should have taken
because of unfavorable conditions in the market. Those who survive this stage of naivete
learn to design a better way of trading. When they become confident, the second enemy
comes to their door. Confidence makes them greedy, they risk too much money at one
time, and a short string of losses blows them out of the market.
If you trade with half of your account on every trade, your ruin is absolutely guaranteed.
If you risk a quarter of your account on each trade, you also likely will never survive long
term in the market. A short losing streak will completely wipe you out. Even risking a
tenth of your account on every trade is being more risky than one should if they want to
stay in the market long term.
Professional traders cannot afford to lose more than a tiny percentage of their equity on a
single trade. An amateur has the same attitude towards trading as a foolish gambler has in
Las Vegas. The more money they bet, the more they ll make. WRONG, even the most
successful traders in the world have losing trades, even strings of losing trades and
traders have to insure that the least amount of their capital possible is to be risked each
time.
This is one of the areas of trading where it is absolutely vital to treat trading as a
business. It cannot be treated like a game if one wants to make money. No smart
businessperson would do something to risk half, a quarter, or even a tenth of their
business in a single transaction. Trading has to be dealt with in the same manner. The
general rule to follow is if you are day trading to never risk more than 2-2.5% of your
total equity on any given trade. This means that on every trade, if you trade with 10
percent of your equity, and you will have a stop loss that limits your losses to no more
than 25 percent of that amount. When doing long term trading, like with the 5Minute
FOREX System our stop loss and risk per trade is normally much higher, but this is
okay because of how infrequently you trade compared to day trading. The second rule is
to never have more than three trades open at any given time. So the maximum about you
will ever have at risk is 6-7% of your account when day trading. For those starting with
less than $10,000 the rule for them is to only trade one currency at a time until your
account reaches $10,000. If you are trading with an e-mini account then it is the same,
except you would trade one currency at a time until your account reaches $2000. Trading
in this way will insure that you do not ever wipe out your entire account with a short
string of losses, which can happen with even the best of trading systems and the sharpest
of traders. There is no system in the world that wins 100 percent of the time.
Most beginners have absolutely no rules of money management in their trading strategy.
They risk more capital on trades that look really good to them. They risk less capital on

trades they are less sure about. This never works in the long run because there seems to
be a frustrating version of Murphy s Law found in this aspect of trading: trades that you
risk more money on will almost always be the losers and trades that you risk less capital
on will almost always be the winners. So now we move on to another way to use money
management to insure a steady increase in profits.