Money management is a set of rules developed by the day trader that supports a complete trading system.
It is possible to search the net for money management systems. However, I always recommend that the trader develops their own system. The trader that develops their system has a greater understanding of the component parts. However, and more importantly, the trader has a sense of ownership. It is this sense of ownership that will keep the trader from jumping from one system to another when the going gets tough.
A typical money management system will dictate that no more than a certain percentage of funds be risked on any one trade. This sounds pretty straight forward. However, the nuances of trading are what can make it difficult.
Let's assume that a day trader has an account balance of ten thousand dollars. What is an appropriate amount to risk on one trade? The amount should be large enough to produce as large a profit as possible when the trade works in one's favor. However, it should not be too large, because one will lose a large portion of one's assets if the trade goes against him. What is the right amount? Experts the world over agree that no matter the size of a trading account, traders should never risk more than 2% on an individual trade. Therefore, if the trader in this example has an account balance of 10,000 dollars, he should risk no more than 200 dollars on a trade.
Two hundred dollars may appear to be an extremely small amount to risk, so let's do a quick study. Let's assume there are two traders placing the same trades in the same market, but one is risking 2% on each trade while the other is risking 10%. If both experience four losing trades in a row, after the fourth trade the aggressive trader will have an account balance of six thousand, five hundred and sixty dollars. The conservative trader will see his account decline by seven hundred and seventy six dollars, or a balance of nine thousand two hundred and twenty dollars.
The above example is just one reason why conservative money management is a solid approach to day trading. The aggressive trader has seen his account draw down by 35%, while the conservative treader has only experienced an 8% draw down. To recoup their loses; the aggressive trader must grow his account by 52%, the conservative trader need only grow his account by 8%.
Day trading, by definition, is a volatile, aggressive way to speculate in the markets. However, taking a conservative approach within the various aspects of the trade will help ensure a day trader's long-term success.
Peter Trout - Peter Trout is a former member of the U.S. Air Force and entrepreneurial day trader. He is writes on a variety aviation and trading ...
