Money management is the science of how to manage your money and capital properly. Some traders believe that knowing and applying the rules of money management is even more important than having a trading strategy. We believe that money management is as important as a solid trading strategy.
Why money management matters
Rookie traders keep searching for the Holy Grail, a trading strategy that would bring them 90% or 100% profit. Meanwhile, a smart trader who practices money management can generate profits even is the average yield of his strategy does not exceed 60-70%.
It may be hard to believe, but it’s enough to make only eight trades a month, four of which will be profitable, and the other four may be in the red. Eventually, however, your trading account balance will be in surplus, all thanks to Money Management.
Basic money management rules
Now it’s time to take a closer look at the basic rules of money management.
- Do not chase high profits. Little by little, one travels far. Open a smaller trade first to see how it goes. Only after your forecast confirms and you make sure that the market isn’t going against you, you can start adding volume to your position and open more trades in the chosen direction.
- Always use a Stop-Loss order on your trades. Now, read it again to let it sink in – Always use a Stop-Loss. Even if the price goes in the right direction, your position will be still vulnerable while it remains open. If you traded at least a little, you already know that the market is unpredictable, especially during the news releases. The market can easily reverse and go against you. That’s when the Stop-Loss comes into play to prevent you from losing more money. So, make it a habit to place this type of pending orders to protect your trading.
- Use a trailing stop. If the Stop-Loss will save you from losses, the trailing stop guarantees you at least some minimum profit, if something goes wrong.
- Avoid trading more than 4% -5% of your deposit. You’ll be able to keep your head cool if your losses are small. And taking control of your emotions is half success.
- Do not look for highs/lows of the trade, follow your trading strategy. Fear of earning less often stands in the way of a trader’s success. When a trader sees that luck is on his side and the price is moving in the right direction, and he often starts to look for a reversal point to lock in his profit. The slightest price fluctuation in the opposite direction, and he closes the trade. Then he sees that the price keeps moving further, the trend continues, and he is already out of the game. That’s why you need to have a strong trading strategy – to eliminate this emotional burden and anxiety from your shoulders.
- Don’t be greedy. Having reached your planned profit zone – lock it in. Don’t try to hit the jackpot, you will most likely return to zero. You’ll have to top up your account and start all over. Remember that making $10 is much better than losing it.
And the last tip for today. It’s not directly related to money management, but it’ll also help you preserve and grow your deposit. Diversify risks, i.e. allocate your money between different asset classes – trade currencies, stocks, commodities. This will help offset the risk in case of negative performance of some assets through positive performance of the others.
Mastering money management is easy, there are not many rules and they are quite simple. The main difficulty is to follow these rules and not to deviate from the chosen course even when “it seemed to you as the right trading decision at the time” and you were “sure that the price would go down” or you “ panicked that you’d lose everything and closed the trade”, etc.