Everything about Money Management
Before going through the various types of money management, we should first understand why is it good to use a MM plan, when money management should be applied and other important issues.
What is MM?
As we stated before, MM is not pyramiding in, scaling out, trailing stops, etc. All this is part of a different subject called risk and trade management.
MM only refers to how much of my account will be at risk in my next trade.
Why use money management?
If you have been around trading for a while, have read a few books or some credible websites you will see that although they tend to disagree about most things, they do agree about one — MM is the most important aspect of trading regarding losses and profits. It can boost your profits considerably and at the same time could limit your losses.
Take for instance the following example:
The following hypothetical trading scenario where you reach a string of consecutive winning trades.
If you had a 38 consecutive profit windfall, would you rather use money management? I think so, almost a $100,000 gain in profits is the difference between the two approaches.
Money management allows your profits to grow geometrically. However, at the same time it limits your losses, take for instance the same hypothetical scenario applied to a string of losses.
Risking 3% on each trade
After 33 trades, when using no money management the trading account would be at $1,000, a 99% drawdown. On the other hand, when using MM, after 33 losing trades, the account balance would be at $35,599 a 63% drawdown.
The results are self-evident, MM allows our capital to grow geometrically but at the same time it avoids the risk of ruin.
Another important reason to use money management is that not every trade will be a winner. Even the best systems are only right about 60 or 70% of the time. For every 10 trades there will be around 3 or 4 trades that end up in red. If we do not learn to take controlled risks, we could blow up our trading account losing only 3 or 4 trades out of ten.
On what kind of strategies MM should be applied?
In a few words, on every kind of strategy. It should be applied when day trading, position trading, scalping, long term trading, and every type of trading approach. If you trade, then you should apply MM.
MM helps you regardless of the strategy you are using, if you trade breakouts, or do trend following trades, countertrend trades, MM will help you.
When should I start using MM?
Right now! You should have done so on your last trade. We hope we have illustrated MM is an extremely powerful technique that will help you boost your profits (allowing them to increase geometrically) but will also help you on the risk side (avoiding the risk of ruin). It does not matter what the size of your trading account, how long have you been trading or even if you are paper trading, you should start using money management now.
Many successful traders point to MM as the single most important aspect of trading. Practicing MM now will help you either to achieve success more rapidly or to avoid devastating failures.