Money Management – How Does Your Strategy Stack Up?
If we were to poll brokers about customers who “blow up” their accounts, I would venture to guess that most would say the losses came from poor money management by their clients. A trader or investor without a plan to follow with each trade is just another person waiting to lose it all.
Sometimes the most important part of an equation is consistency. If I were to give you 5 math problems, all of them basic algebra, and you used the PEMDAS technique you learned in grade school, you would probably get them all correct. However, if I gave you the same five, and you had no plan to answer the questions, I’m sure your answers would all be different as you tried each and every way to solve the question. Maybe, eventually, you’d get them all correct, but you would’ve still wasted plenty of time just in creating a strategy you should have had long before you started solving the problems.
Are you consistent?
As demonstrated above, consistency is the most important part of a trading plan and proper money management. If you’re staking 5% of your account balance on one trade, then 50% the next, do you really have a reason as to why one trade gets 10 times more of your account than another? Is it because the second trade is 10 times less “dangerous?” Or is it because the trade is 10 times more likely to be profitable?
If you can’t answer those questions, then you’re doing nothing more than gambling. Each trade, for you, should be marked with a best, worst, and “what I expect” outcome with which you use to determine how much you’ll assign to each position.
The Bottomline
Risk should also be properly matched with reward. I, for one, plan to lose no more than 10% of my account balance per trade in my options account. When I see a play that looks like a 200% return, I usually ante around 5% of my account. Of course, to do that, I have to know that the risk of losing it all is not greater than 33%. If it is, I’m playing to lose.
In this period of volatility and uncertainty everyone should take just one step back, a deep breath, and review every single trade and investment they have made in the past year. If you stare long enough, you might just find that the volatility and uncertainty might just stem from your own strategy.
Yes…that’s right, money management is very important in trading and investing. I have seen many traders failed in trading because they have bad money management. I think this has got to do with emotions as well. When they see that they are on a winning streak, they tend to risk more per trade.
For me, I’m a conservative trader and I only risk around 3% of my capital per trade. What about you?
Dan