While it’s probably one of the most misunderstood terms in all of trading, plenty of professional traders call money management the single most important skill that separates retail traders from the pros. But what exactly is money management, anyway, and do you have proper systems in place to ensure your compliance?
Far more than just slapping some arbitrary stop loss on all your positions, or risking no more than 1-2% of your trading account on any one trade, money management involves a complete set of rules that govern risk, stop placement, when to exit and/or take profits on winning positions, how to accept and minimize losses on failed set-ups, and more.
So don’t just talk about money management; start going about it. And, using the guidance and important considerations we’ll set forth in the ensuing discussion, elevate your money management skills to make your overall trading process smarter, more efficient, and most of all, more profitable. Here are some ideas for how to do it…
Money management is a common term among investors, too; in fact, in that sense, it’s an industry all its own! However, money management for traders has an entirely different meaning. For us, it’s a complete set of rules and processes that governs how your money is handled starting with when (and how) it enters your account, how it’s put into place in the markets, and how proceeds and remaining capital from your trades are returned and/or distributed once you exit positions. Some key individual components of money management for traders include:
Before trading even begins, responsible money management entails funding your trading account only using capital that’s 100% discretionary, as opposed to money that’s usually allocated for paying monthly expenses, buying food and children’s clothing, or going towards education or retirement account contributions. Not that it’s a positive or desired outcome, but you must trade only with money that you’re willing and able to lose in its entirety without compromising your lifestyle. So, needless to say, betting the mortgage money or the kids’ college funds on the markets is simply out of the question!
Many inexperienced traders believe that money management begins and ends with risk, and while there’s much more to the equation, risk is certainly a central component. In this respect, it requires trading a position size that’s sensible considering your own skill and experience levels, never abusing leverage, and never risking more than 1-2% of your total trading account value on any one trade. Furthermore, prudent money management calls for establishing a stringent reward/risk profile and taking only fully qualifying set-ups that meet or exceed those requirements.
More than simply placing a stop with each and every position, money management calls for a disciplined and proper hard stop-loss, placed in the market according to a set strategy. For example, if trading short on the heels of a bearish pin bar reversal, a well-designed strategy may dictate that a stop be placed at the daily or weekly pin bar high, plus spread, plus an additional pip. It’s precise and almost scientific in nature, and by design, stop placement is intended to give the trade enough room to work out while also preserving and protecting capital should price go the other way instead. Afterall, when it comes to money management, one of the primary considerations isn’t how much you stand to win if the trade goes in your favor, but how best to preserve capital and minimize losses whenever a trade moves against you.
In large part, traders can keep from giving back hard-earned profits by having a well-designed exit strategy and using it as a condition of trading. For example, orchestrating a sensible exit once a winning trade approaches a certain technical juncture, whether a Fibonacci retracement level, trend line support/resistance, swing highs/lows, or a moving average. Most prudent traders will begin to scale out at that point, or book full or partial profits, all the while maximizing profits and using the common-sense notions of pure price-action trading to their full advantage.
For most traders, the only thing worse than giving back hard-earned profits is leaving money on the table whenever a winning trade continues even after they’ve exited the position. This is why taking partial profits and letting the remainder of the position—perhaps 50%—run, is advisable a lot of the time. As part of an effective money management strategy, we advocate and teach a technique that involves trailing a stop behind every second buyer or seller bar, depending on the direction of the trade, in order to let profits run, but at the same time, avoid giving back profits once a momentum trade has gone on for a while
Perhaps the one area where money management for traders is similar to money management for investors is in the long-term focus on growing and protecting capital that’s common in both. And while it requires being vigilant and proactive in the short term as well, both traders and investors realize that being willing and able to accept (small) losses on the road to longer-term growth and prosperity is simply “part of the game.”
With that, money management also involves putting your pride aside from time to time, admitting you’re “wrong” about a position, and resisting the urge to move a stop or add to a losing position in hopes that it will still turn around for you. Conceding defeat and keeping capital on hand for the next opportunity is, by many measures, what effective money management for traders is all about over the long term.
Money management is one of many key disciplines that play a direct role in your success in the markets. For help mastering it, and for personalized mentoring and instruction, plus timely trade ideas, continuing education, and lifetime trader support, join The Lazy Trader community. Click below for information, to explore the many benefits, and to get started with no risk and your full satisfaction guaranteed!