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Setting your Maximum Loss is good Money Management Strategy

After defining your trading float, the next thing that you need to do in setting an excellent money management strategy is to define what your maximum loss is. The maximum loss is quite simply the maximum amount of capital that you’re happy to lose on any one trade. The reason for defining this upfront, before we even open a trading position, is to make sure that we can stick to one of the cardinal rules of trading and that is to keep our losses small – ensure that you abide by your money management strategy.

We want to make sure that we set what our maximum loss is and make sure that’s a small percentage of our trading float so it won’t have a detrimental affect if we have a string of losses. If 95 percent of traders end up losing money, the primary reason for this is because they haven’t applied proper money management strategy.

Let’s look at an example of poor money management strategy. If I had a trading float of only one thousand dollars, and I’d began trading risking 100 dollars, with most trading systems, it could be very reasonable to experience three losses in a row. If I were risking 100 dollars, obviously my trading capital would have now reduced to 700 dollars.

Now, what do you think those 95 percent of traders with poor money management strategy say to themselves at this point in time? They go, “Well, I’ve already had three losses in a row. So, I’m really due for a win now.” And, that’s when they decide they’re going to bet 300 dollars on the next trade because they think they have a higher chance of winning.

This just isn’t the case and I suppose we could draw parallels back to the story before, when I was talking about going down to Crown Casino and I was waiting for a string of blacks in a row and then I would bet on red. Effectively, this type of trader that I’ve just described is ignoring their money management strategy and doing the same thing. Assuming that person did bet 300 dollars on the next trade because they thought they were going to win, if they lost this time, now their capital would be reduced to only 400 dollars. The chances of making money now are very, very slim. They’ll need to make 150 percent just to break even.

Similarly, here’s another example of poor money management strategy and a perfect illustration why most people lose money in the market. If we again, start out trading with 1,000 dollars, and we begin betting with 250 dollars, then after only having three losses in a row, we’ve now lost 750 dollars, and our capital has been reduced to 250. Effectively, we must make 300 percent return and that’s just to break even.

In either one of these cases, the reason for failure was because the person risked too much and ignored their money management strategy. Remember, the goal here is to stick to your predetermined money management strategy and to keep your losses as small as possible while also making sure that we open a large enough position so we can capitalize on profits as well.

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