Mr. Raman is a trader. Today he is shocked to see that his trading account has only Rs 75000/- .
Last month he was up 200% and his account had reached Rs 450,000/- But after recent market reversal, he is left with a small fraction in his account.
What is wrong with his trading?
Correct answer is money management and inadequate capital for the trading business.
Money management is one of the most important aspects of top trading and investing systems.
Money management does not mean diversification or dividing money in to various investment instruments.
Money management is risk management based on tested algorithm that gives answer to how much?
It means calculating the exact size of position that keeps risk in control for every trading or investment position in the market.
There are three major reasons that do not allow investors and traders to practice sound money management.
- Lack of knowledge: Average investor and traders do not invest time and effort in learning prudent money management techniques.
- Inadequate capital: Investor and traders take enormous risk because their starting capital is too small. If an entrepreneur begins a restaurant business with a few thousand rupees capital, he is setting up himself for 100% failure as his initial capital is too small.
- Discipline: Greed and fear are primary cause of most trader failures. This makes mental discipline as one of the toughest aspects to learn and practice.
Money management allows traders to reach their financial goals, provided they are trading a positive expectancy trading system. Positive expectancy means that the trading system will make money over a series of trades.
This is similar to a batsman (like Tendulkar) having good batting skill is certainly expected to make runs over a series of innings.
Money management also ensures that there are no big ups and downs in our trading account by restricting us to take only calibrated risks. This ensures our survival, till markets turns in favor of our trading system.
Money management quotes by top traders:
- “Never risk more than 1% of your total equity in any one trade. By risking 1%, I am indifferent to any individual trade. Keeping your risk small and constant is absolutely critical. ”
- Larry Hite
- “You have to minimize your losses and try to preserve capital for those very few instances where you can make a lot in a very short period of time. What you can’t afford to do is throw away your capital on sub-optimal trades.”
– Richard Dennis