Money management in trading is keyword to managing the portfolio, I think it is the mandatory step to take before buying or selling a financial instrument.
Today we hear about charts, technical analysis, strategies, algorithms, platforms with 1000 features, only at the end is money management explained. Nothing more wrong, I prefer to exaggerate but that’s what I think, from experience some traders get conditioned by the market, news etc… and they can’t wait to open a position without planning a strategy to better manage money.
When I started, the first thing my university economics professor (also a fund trader) taught me by asking me two simple questions:
- How much are you willing to lose?
- What percentage of capital can you invest in each transaction?
I still remember my expression now, trading is not just pushing a red or green button like when playing roulette, money management is an essential pillar because you have to learn to protect it from market traps, mistakes and from yourself (emotional).
First of all you have to know the starting capital, investing involves risks so you have to think that you can lose in part or all if you make mistakes all the time. If you invest in derivatives like futures for example, you need to know that you will be required a margin from the broker, so it is a different type of management than buying a simple Apple stock.
Money management is used to determine precise rules before entering the market:
- Risk a maximum of 5% on each transaction, 3% if the risk-to-return ratio is high
- Set stop loss/take profit and add trailing stop to secure profits
- Know how many operations I can do per day/week/month
- Plan potential gain targets on each location
- Manage a few positions at a time
- Invest a maximum of 50% of capital on multiple transactions, 50% keep it as liquidity on the account
Not respecting money management’s rules means losing part or all the capital, believe me I met “normal traders” and “pro traders” who were crushed by the market. Unfortunately, someone gets emotionally involved like at the casino and then he can’t get out of the hole.
Another important step, for those who start above all is the minimum starting capital, this depends on both you and the broker (IG starts from at least 10000 euros, TradeStation and others not), a tip is to start with at least 3000/5000 euros/dollars. I tell you this because you have to count platform fees, losses, actual costs of financial instrument and any margins.
Money management should make you think about the capital you are going to invest, remember the golden question: how much am I willing to lose?