When creating your Written Trading Plan, one topic that must be included is your Trading Money Management. This is because good money management can really boost the performance of any trading system & take the worry or fear out of Trading, putting your mind at ease knowing you have a system in place to protect your hard earned Investment Capital.
As a trader its easy to be instantly attracted to the Reward or potential Profit, but there 3 simple questions that must constantly be answered before considering the Reward.
1. How much Risk is involved
2. How do I limit my Risk
3. Am I comfortable with the Risk
For these question there is no right or wrong answer, only each trader can answer this for themselves, as the answer is different for each trader according to their comfort level and situation. The best way to combat this risk is to utilize some Trading Money Management techniques to minimize the risk you accept in each position and your entire portfolio.
Understanding the Risks
But firstly lets understand the Risks that are associated with trading. Because Trading is a probabilities game, and nobody actually knows how the market will behave with 100% certainty. We must try and reduce the risk carried, so our Portfolios are not wiped out if we are wrong or if something occurs in the market which unexpected. Reducing the risk can prevent large Portfolio Capital draw down and also serve Psychological draw downs, which are both important to avoid for your Long term Trading success. So the key here is to preserve your Account Equity so you can fight another day!
Here are some Trading Money Management points for consideration below:
1. What type of Securities will you trade
- Are you simply going to trade Stocks or are comfortable with leveraged Options, CFD's, futures etc. Of course with the more leverage you utilize, the great the risk you are accepting.
2. Capital Allocation
- How much capital will you allocate per trade, or more importantly how much money are you prepared to lose if you are wrong. For those how are new to trading and want to keep things simple, a good place to start is "% of Capital Risked per Trade"
- How many positions will you have open at once. By diversifying your positions your portfolio is not affected as much if a particular trade moves against you.
- If you have multiple portfolios, how much capital per portfolio.
3. Risk to Reward Ratio
- With each trade, how much risk if you are wrong, are you willing to accept, compared to potential reward if you are correct. Risk to Reward Ratio is something I've mention in some of my previous posts and will I expand on them in the future.
4. Event Risk Management
- Will you carry positions into Earnings Announcement or important market announcements such as Federal Reserve announcements etc. This is especially important if you are trading leveraged instruments such as options and CFD's.
5. Market Trend
- What is the Market Trend? Short Term and Long Term. Is your Portfolio in tune with the Market Time-frame I am trading. Is your Portfolio capital overly Bullish or Bearish biased compared to what the Market is telling you.
6. Market Sentiment
- What is the Market Sentiment? Is the Market showing signs of Complacency, Indesicion, or Fear. Adjust your Portfolio accordingly.
7. System Success
- Is the Trade Entry System you use suited to a particular market environment. How will you tell if its stopped working. How will you calculate how accurate the system is.
It is also worth noting that as you diversify and lower your risk you are likely to diluting the reward or performance, so it is a balancing act to accept an amount of Risk that suits your Risk profile and the amount of Reward that you would be satisfied with. This is a question on each Trader can answer for himself.
With Trading Money Management being such a vast topic I will cover it in greater detail in future posts.
I hope that you are enjoying this blog series on the “Top 10 questions a Trading Plan must answer“. Below are all the posts in this series:
- What are your Life Goals & Trading Goals?
- What is your Trade Entry Method?
- What are your Trade Exit Methods?
- What type of orders will you use to enter & exit?
- What are your Money Management Techniques ?
- How will you manage your Position Risk versus Reward?
- What is your Process for Open Trade Review & finding New Trades Picks?
- What is your Trading Success Profile?
- How will you Review your Trading System to measure & improve?
- What is your Trading Daily Routine-(Part1 & Part 2)?
Stay tune for next weeks blog on "Managing your Position Risk to Reward Ratio".