Money management means the ordered control of your money so that you never take anything other than what is known as a businessman’s risk, as opposed to the plunging type of behavior that is so well known by beginning traders.
Money management is about computing how much you can afford to lose and keeping trade sizes sensibly small.
As a rule of thumb, you should never put more than about one-sixth of your total capital at risk at any one time. This means that if you start out with, say, a fund of 1000 Dollars, Pounds or Euros (or whatever currency you are used to dealing in) you will never allow a situation to develop where you can lose more than about 160.00. You might buy a contract at 32 per point, setting your target sell point at 5 points above your buy. You will, of course, have been continuously doing your homework on the trend of the instrument you are interested in, the volume of trading that went along with that trend and such matters as the time of year and the political, fiscal & monetary situations.
20 stocks at £5k each
Each stock has an initial stop at 5% below the buy price.
Each stock has a trailing stop of 10% or 40ema.
The maximum you lose on one trade is 0.5% of your trading pot.
The maximum loss you can suffer total is 10% of your trading pot.
If you scale into the market on bull reversal and scale out on bear reversal your max loss is likely to be a good bit less than 10% drawdown.
With a max 10% drawdown you know the year end gives a profit once your pot is more than 10% in profit.
If your pot fails to make 10% profit you are at risk of a small % loss.
Losing 30%, 40% or 50% is out of the question.
If you apply the principles of disciplined trading, as time goes on you will find that your overall fund has increased if you are successful. At this stage the one-sixth that you can afford to put at risk will be a larger absolute amount.
In order to not end up in a situation where a market crashes unexpectedly you can utilise one of the risk mechanisms offered by a spread betting provider to know the maximum loss you may be exposed to in advance. A ‘stop loss order’ will mean that you can go away on holiday, with the peace of mind of knowing that the market cannot affect your trade that much further than the limit you have set.
Risk Management: Practicalities
Generally speaking, a nice tight stop will produce a bigger position and a wide stop will produce a smaller position. The outcome of the trade in loss terms is always the same. It’s a mental shift but when you understand that making money comes from compounding….it doesn’t much matter what your pot size is…it’s how you use it.
Let’s suppose that your pot is £45k? So decide how much loss you can stomach per trade and never lose more than that. Let’s call it £450. So let’s say you want to go short a £1 stock with a target of 90p and a stop at 1.05. You will lose 5 points if the trade goes tits-up….so that’s £450/5 = 90. You go short the stock £90 per point. Now let’s say you want to go short a stock with a stop of 1.10. You will lose 10 points if the stock goes tits-up, so this time it’s £450/10. You go short the stock £45 per point. If the first trade works you will make £900. For the next trade your pot is now £45.9k and your next calculation is based on this figure. If the first trade fails, your pot is worth £44.55k and you base the next trade on that. So you see, your pot is perfectly fine as it is. You’ve just got to find more trades that work an size them correctly.
If you are going to trade then you have to accept small losses. If anything actually worked all the time we would all switch to it and by definition it would stop working. Small losses are very much part of the trading game. But look at that Thomas Cook trade….assuming you took the entry in March/April, it would make up for a plethora of trades that didn’t work. That’s trading. If you find you are taking more losing £’s than winning £’s then you have to stop trading and work out why.
“I will cut and run” – a trader doesn’t necessarily need to have a high win-loss ratio to be profitable, cutting your losses early and letting your profits run is a psychological test that is preached by many but practiced by few.
Risk management: Stop and Limit orders
Stop losses serve to cap your downside potential by automatically closing a spread bet as soon as the market passes your chosen trigger value. Whenever you decide to trade a particular market, you need to ask yourself at least one key question: what price would I back out at if things go against me? Your answer will be the price at which you set your stop-loss order.
- Discipline, understanding, and not bet more than your means.
- A stop is to stop your loss, effectively preserving one’s capital, to keep you in the game…
- The larger spread is how the spread betting companies makes their money – fair doo’s.
- ‘Most times punters end up doubling up on losing trades’ – well, I would definitely stop if I was mainly getting it wrong, but I disagree with this. if you apply a consistent set of disciplined rules and only trade on key charting points with stops – you should ensure continuity of playing the ‘game’.
You will have your stop-loss strategy worked out. This will determine the point at which you will close your position, even if it is at a loss, in order to protect capital and minimise the risk to your overall, on-going position. It is this ability, to recognise when to take a loss and then to go ahead and take it, that decides whether or not you are a truly disciplined trader.
With a long position a stop loss could be placed somewhere below the trade entry level, say, 15%. In the circumstance that the market were to fall and hit your stop, your spread betting provider will close your trade at the next available price. With a short trade a stop loss is instead an order to buy at a price above the entry sell order.
Please note that normal stop loss orders are not guaranteed and may be subject to slippage or gapping. In this respect guaranteed stop loss orders are safer than normal stop loss orders, as they guarantee to close your trade at the exact trigger value you have set, regardless of market gapping. However, guaranteed stop loss orders aren’t free and subject to a wider bid-offer spread unlike normal stops that are free to place.
Stop Loss Order Example
You believe the FTSE 100 is likely to rise by 200 points over the next few weeks from its present level of 5400. So, you open a ‘buy’ or what is commonly called a ‘long trade’. From looking at the FTSE’s price chart, you determine that you would change your mind about where the FTSE was headed were it to drop below 5341. So, you place a stop loss order at that price. If it drops that far, your spread bet will be automatically closed.
Rather than rising as you had hoped, the FTSE 100 moves in the opposite direction to your trade i.e. falls in value. Within a couple of days, it touches 5341, triggering your stop loss order. Your trade closes at the first available price after the market hits your stop level, leaving you with a loss of 59 points, multiplied by your stake.
After dropping to 5330, the FTSE reverses direction and starts recovering. Within a few days it reaches your original target of 5600. You feel like biting yourself: you were right about where the market was going after all, if only you had set your stop loss a little further away or had not utilised one at all!
Seeing your stop loss triggered and then watching the price do exactly what you thought it would is undoubtedly a frustrating experience. However, it is part-and-parcel of trading and you must learn to take it. The worst thing in the world you can do is to succumb to the temptation of utilising huge stops or none at all. Every trader has done this at some stage and has ended up regretting it, even if he enjoys success to start with.
Spread betting companies will allow you to place limit orders and stop-loss orders. A limit order will not be filled immediately, and may not be filled at all, unless the buy or sell price reaches the value at which you have set the limit. This is useful if you have taken a view on the way a particular instrument will move, but cannot be in attendance at wherever you track prices at all times. It is also used to sell at the target price where you have determined you will close your position. And you should always have a target price for closing your position.
A stop loss order will be triggered when the price moves in the direction opposite to that on which you have bet. But stop losses are problematic, especially when combined with spreads. A temporary drop below your stop level is not a problem early in the life of a contract, so long as the price subsequently recovers, but it will trigger your stop order and at a higher or lower level than you might like because of the spread. Many traders do not use stop loss orders, but apply a so-called mental stop. instead. This means they will close the position manually depending on (1) how close the price is to the previously determined stop level and (2) how far the contract has to go to expiry.
The absolute necessity of keeping records
It is of vital importance that you keep records of every trade you make. These records must go a lot further than simply noting the dates and the prices at which you have bought and sold. They must record the reasons why you did so as well. This is useful for later revision of your development, but the primary purpose is to ensure that you did, in fact, have a valid reason for your action. It forces you to think through the reasons why you made and acted on a particular decision.
Hopefully, and in time, your notes will record that each trade was entered into for a good reason and the position was closed when the target price was reached, but this is unlikely. Trading is not a precise science, in spite of the activities and beliefs of some who engage in technical analysis. Your records will log errors of judgement, lack of concentration, even outright mistakes, such as pressing the wrong key on your computer keyboard at a crucial time. Hopefully they will also detail moves that preserved capital, instances where Lady Luck smiled on you and the occasional textbook entry, where you entered and exited your position with confidence and aplomb, showing a useful profit in the process. But you’ve got to keep the records.