Money Management in Trading

First of all let’s clear things out, trading is difficult. Only a small percentage of those doing it are profitable. The reason for this is two-fold, one is for lack of a trading plan and the other is poor money and risk management. These two things include the whole essence of trading. At this point I have to underline that in my experience scalping doesn’t work. You have to look for bigger moves, otherwise you will be trapped in the statistical variance of the price i.e. noise.

A trading plan means first of all knowing the bigger direction. This is very important. If you get the direction right then you can maximize your profit. However it is easier said than done because knowing the bigger direction doesn’t mean that you open positions to that direction wherever price is. You need a system or a model that will have a good success rate, at least above 70%. The higher, the better. This model will give the entry levels. However, no model can always give entry levels with exact accuracy. Price movements are probabilistic which means there is no level with 100% certainty. How you manage this uncertainty is one of the most important aspects of trading.

A good methodology is to divide the whole position in 3 entries of 1/3 each. In this way even if you are wrong you usually get the chance to escape in the majority of cases. You can also remove the two worst 1/3s at b/e (with zero loss) when price gives you the chance and remain with the best 1/3 until things get clearer. The total size has to be calculated according to the right position of your stop in order for the risk not to exceed 3-5% of your balance. Stops should be on a daily close basis which means that only a daily close below or above your stop (depending on whether you are long or short) cancels the trade and you close your position. Spikes through your stop level don’t cancel the trade without a daily close. Unfortunately fixed stop positions can be seen and this is what in most cases algos are targeting. So you must not set a fixed stop. You can use a stop alarm that will inform you if price has gone beyond your stop level so you can start monitoring it. But what if price spikes hard your stop level? Of course you can’t keep it going and lose all your capital. That’s why you need to decide on your hard stop in advance. This level will be related to your level of risk and relative to your account balance. A good strategy would be to have your hard stop protect prior months’ gain. So if your prior month had a 20% increase (very realistic) then you can go for about 10% total loss for the hard stop.

There are certain times when you will anticipate a larger move that will last several days. At that times it will be useful to start building a basis position, a core position, for that bigger move. As soon as price starts moving in your favor you can also day trade but only in the same direction. You don’t want to get confused emotionally trying to play both directions. Day trades and core position trades will be executed using the same division in 3 parts scheme.