Money management is a defensive approach to trading. The aim of a money management trading strategy is to ‘live to fight another day’. The strategy involves protecting your capital and making sure that you have enough money left to continue trading.
Managing money is all about managing risks. You need to have a clear risk management plan to limit the risk of suffering any loss.
Table of Contents
Proper money management represents a work in progress that requires discipline, patience, and knowledge. In order to help you improve your money management skills, here we have compiled a list of seven effective strategies used by professional traders to effectively manage money when trading.
Big Trends Lead to Bigger Profits
Trading is all about understanding trends. The longer a trend lasts the greater the chance of making a huge profit.
For this very same reason, you should not rely only on short-term trading. The losses may be low in cases of short-term trading, but the profits will also be smaller. In fact, these small losses in the short term can add up to a significantly much bigger loss.
In contrast, you can expect to grab a bigger piece of the pie when you invest for the long term. With a long-term outlook, you can have a more positive expectation regarding the size of the profit since the trend is longer. The longer the trend, the more accurate will be the validation of the trend. In this way, you can confidently invest in large sizes with the expectation of making profitable returns.
The short-term predictive system won’t allow you to validate the trends over the long term. Short trends result in fewer profits. Moreover, the transaction costs involved in short trades will affect profitability to a greater degree as compared to longer period trades.
Avoid Relying on Win-Loss Ratio to Detect Trends
Traders should not rely on the win-loss ratio when analyzing past trades. The ratio is a favorite among new traders. However, the fact is that it has limited use for determining trends.
The win-loss ratio reveals very little information about trends. You can experience more losses than wins but still, remain profitable. This is the case if the value of the wins is more than the losses.
Your key to a successful trade is keeping an eye on large moves during a period. By analyzing, several large moves during a particular period, you will be able to more accurately determine the trends.
Relying on this strategy to determine trend will help you to reduce the losing positions. The strategy will allow you to enter into big profitable trades, and the losses from losing trades will be less.
Be Prepared to Take Calculated Risks
Successful trades require making some calculated risks. You cannot make a profit without taking any and suffer some losses along the way.
The amount of risk you take depends on your risk appetite. In other words, you should consider how much you can afford to lose to make a profit.
For instance, if you seek 80 percent profit during a year, you should be prepared for a 20 percent loss. You cannot realistically expect a 100 percent profit with 0 percent chance of losses. You need to accept that losses and gains have an unshakable link in any trade.
Know Your Risk Profile
You should know your risk profile — aggressive, moderate, or conservative — as it will help determine your trading strategy.
Aggressive risk tolerance is only viable if you have a deep understanding of the market position, or you don’t really care about losing money or you regard trading as gambling. This strategy will result in maximizing your ROI at the risk of incurring large losses.
Most traders would want to adopt a moderate or conservative risk profile. This strategy involves taking some risks but adopting an overall balanced approach over the long run. Examples include combining some volatile securities with blue-chip stocks or securities with stable returns. A typical strategy entails investing some of the funds in growth and some in dividend-paying stocks.
Don’t Make Trading Decision on Margins
Margin requirements should not be a big consideration in trading. For instance, in case the margin for a stock or any other commodity increases from $3,000 to $6,000, you do not necessarily have to decrease the number of shares you buy.
Your main consideration should be the trend and profit-making potential from a given trade. Whether a margin increases or decreases, should not affect your money management decisions when trading.
Adjust the Strategy for Each Trade
The money management strategy should not be the same for all contracts or shares. You should make rules depending on the specific situation of a particular security.
The fundamental and technical analysis results should dictate your money management strategy. You should use different formulas to determine trends for different commodities.
If you use a constant strategy, you will lose out on the money-making strategy. Often, a particular strategy that has been successful with one type of security turns out to be disastrous for another. Moreover, the required strategy should change with time depending on specific market conditions.
Always Use Stop-Limit Order
You should always use stop-limit order when trading stocks or any other commodity. Stop-limit orders generally work well in minimizing losses.
With a stop-limit order, an order will cancel automatically once a specific price level is reached. You should always set the stop-limit order for every trade.
An important question is where to place the price limit.
Most experts suggest placing the limit near support and resistance levels. A support level is the price level at which investors start purchasing security, thereby establishing a floor below which a price is not likely to fall.
A resistance level is the opposite of support level representing prices at which investors tend to sell a security, thereby establishing a ceiling above which price is not likely to rise.
Support and resistance levels can be determined using technical analysis tools. If you are going for a long position, you should establish the stop-limit order near the support level, On the other hand, if you are going for a short position, you should establish the stop-limit order near the resistance level.
Final Remarks
Money management is a critical skill for traders. The skill is necessary to avoid making devasting mistakes that could literally cause your portfolio to end up in smoke. Successful trading is mostly money and portfolio management. You need to apply effective strategies to efficiently manage your limited resources to make big wins. It’s about minimizing your losses and maximizing the gains.
Effective money management strategies are the cornerstone of success. You will be able to grow your wealth over time with the right strategies for managing money. It essentially will allow you to know exactly when and how much amount to invest for successful trades.
While money management for traders is a broad topic, the blog post will give you an idea of the rudiments of managing money. Money management is important for all types of traders. Whether you are trading in the stick or the Forex market, you should know the strategies to effectively manage your money and grow your wealth.
Photo byLuiza Sayfullina
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