Sound Money Management
By Ultimate Trading
Goals of Good Money Management
One of the most difficult qualities of being a successful trader is learning
good money management. It's completely possible - and actually pretty
common - to see people turn out to be right on a high percentage of their
trades and still lose money. How is that possible? If you don't use good
money management by locking in profits, taking small losses on the picks
you're wrong about, and controlling your use of margin, eventually you'll
lose it all, no matter how good a trader you are.
Protecting your capital is your first step in good money management.
As a trader, the most valuable part of money management is your capital.
Without it, you can't trade at all. Bringing in no profits at all is better
than losing any part of your capital, because if your account is intact,
you can always make a profit another day. If your capital has suffered
a loss, you'll be wasting effort playing catch-up.
Market corrections are inevitable, and will continue to occur from time
to time. Traders must anticipate them and take precautions before they
occur. Properly prepared, traders can even profit from corrections. Without
proper money management, though, your account balance can be destroyed.
Sound money management has two main goals: to avoid losing money, and
to avoid missing profit opportunities by tying up capital in problem trades
for long periods of time. Failing to avoid either of these will cost you.
Avoiding loss of money is pretty easy to understand: You want to preserve
your capital and whatever profits you've accumulated. Not only do you
want to keep it, but you want to trade with it as well, so that your capital
continues to grow and makes your returns larger and larger.
Avoiding loss of profit opportunities isn't quite so obvious, but if you
think about it, it's easy to see the point. Let's compare the outcomes
of two money management decisions.
Trader A buys a stock, expecting it to go up, and finds that it doesn't.
He's just sure it will go up eventually, and he's incurred a small loss,
so he decides to wait it out. He ends up holding the stock for three months
before finally selling it.
Trader B buys the same stock at the same time as Trader A, but once he
sees that it isn't going up, he sells it at a small loss. He buys another
stock and makes a 15 percent profit on it. His next trade loses 1%, but
after that he makes 8 percent, 15 percent, and 30 percent on series of
trades. Because he is growing his account, he makes these percentages
on a larger and larger capital basis each time. At the end of three months,
his account has grown by 48 percent.
Whose money management decision turned out to be the best? While Trader
B made a nice profit, Trader A not only lost time but also never made
his money back. Even if he had made his money back on that stock, it's
hard to see how this was a good use of his capital and proper money management over the course of three months.
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copyright 2005 Money Management