Money management in literal translation means “money management”. In relation to trading, money management is a system of optimal use of funds in order to minimize risks in combination with profit growth. Knowing and following the rules of money management is a prerequisite for conducting profitable trading over a long period of time.
Why do novice traders often lose money?
Violation of the rules of money management is the main reason for the failure of most novice traders. This factor comes first in importance. Non-systemic trading, violation of the rules of a specific strategy these factors, of course, also do not contribute to the success of the trader. However, money management is the foundation of exchange trading. Without following its principles, it is practically impossible to achieve success, regardless of the chosen trading strategy.
Practical tips for money management
Here it is necessary to clarify that the specific rules of money management depend on the level of aggressiveness of the trading strategy. In this case, the rule always applies: the higher the profit, the greater the risk of losing money. Most experienced traders hold conservative or moderate views. In the medium and long term, such exchange players are most successful.
Considering the fact described above, the article will give general principles for effective money management without going deeper into specifics, which in turn depends on the size of the deposit, strategy, preferences of the trader, etc.
When opening a deal, you must immediately limit the loss set a stop loss. This rule cannot be neglected. If a limiter has been set, then the transaction will be closed automatically, even if the terminal was closed. This provides insurance against various force majeure circumstances disconnecting the Internet, electricity, for example. Also, the presence of stop loss is important from the point of view of the psychology of trading.
It is necessary to determine the maximum level of risk when opening a transaction. This means that the amount of loss per transaction should be limited. This rule is actually a continuation of the first. It is generally believed that you cannot risk more than 0.25–1% of the deposit amount.
If the situation on the market is favorable, profit should be developed and partially fixed. An experienced trader always uses a trailing stop that does not allow a profitable position to close at a loss due to a sharp price reversal.
The ratio of profit to loss should be at least 2: 1. For example, a stop loss on an order should limit the drawdown to $ 100, and take profit should record a profit of at least $ 200.
After closing a series of losing trades, you should temporarily suspend trading in order to analyze and establish the reasons that led to the drawdown. In no case should one succumb to excitement and the desire to “recoup” quickly, of course, in violation of the rules of money management.
An important point in the money management system is the method of calculating profits. It is always considered as a percentage of the deposit amount, and not in specific values. 1% of $ 100 and 10 thousand dollars varies greatly. That is why with small investments it is almost impossible to get tangible profits without a significant increase in the level of risk.