As we stated in our Trading Plan article, it is very important to also have a very good Money Management system which is suited for your needs. It should be adapted for each situation and also should complete your trading system so that you will get as much money from the market as possible. With a good Money Management plan even a very easy trading strategy can become a profitable one.
Guide lines for a good Money Management
From the past experience of the traders, it was observed that it is important to lose as less as possible on a trade and look for bigger profits then your risks. This means that you have to use a risk to reward ratio in your favor. You will find in a lot of trading books that a good risk reward is about 1:3 (you risk 100$ to obtain 300$ from the market).
Let’s take some theoretical examples for you to understand better how this risk to reward ratio works.
We take 2 investors with the same initial balance of 10.000$. First investor uses a 1:1 risk/reward, he risk 50% of his balance and hopes to win 50%, and with each second trade is a profitable one. The second investor risk’s 3% of his account but hopes to win 50% (1:16.6 risk/reward) and each second trade is profitable. Both investors are making 10 trades.
The first investor will end up having his account almost erased while the second one has a pretty interesting profit.
In the second example we will get a little bit closer to the reality. The first investor will risk 20% to win 20% (1:1), with each second trade profitable, and the second investor will risk 3% of the account for winning 10% (1:3) and for him each third trade is profitable. They have 10 trades each.
As you can the first investor will have a loss in his account after the 10 trades and the second investor will end up with more than 7% win.
This means that if you adjust correctly your money management you can have more losing trades than wining ones but still end up with a profit.
Out of the Box Money Management
We said it before and we say it again! It is important for you to be able to adjust you money management to suit the situation. If you will pin a certain risk to reward ratio to your trading strategy you will not be able to get the best out of the market.
If you will keep your mind open and think a little out of the box you will see that it is important to:
- Lower your risk if you do not trust a certain setup, but you would like to be in the market in case you are right. This way you will lower your negative emotions and maybe end up in a very good trade;
- Risk more if you trust your setup, but it is important not to do stupid thinks, like risking too much. Your experience and your trading strategy will tell you when you can risk more on a trade or trades;
- Scale in (add more volume to your current trade) when the setup is consolidating and you have signals that tells you the market will move in your trade direction. This way you will end up with some interesting profits at the close of your trade.
- Scale out if you have signals that your Take Profit levels will not be reached so you will put aside some profits but also leave some space for the market to move and still reach your levels.
- Adjust your risk depending on the instruments you are trading on and on its volatility;
- Modify your stops and take profits level depending on the moment of the day and if new signals appear, but never in your detriment;
These are some examples that you can use to adjust your Money Management to suite better with your personality, with your trading strategy and of course with the market.