This quick checklist separates winners from losers
A lot of people fail as traders – their fund gets wiped out, or just given so many tough blows that they lose faith and give up.
Is this because they’re trading the wrong strategy?
Or because they’ve read the Fibonacci retracements wrong?
Or perhaps their spread-betting company is taking too much of a cut?
The truth is that it’s none of these things …
All traders (even the most successful ones) will take wrong turns and use unsuitable strategies from time to time …
The best traders sometimes read the signals wrong …
And we all have to deal with the many and various demands of our brokers …
The single biggest mistake that wipes out traders is poor money management.
Before you groan: “That old chestnut!”
I’d like to tell you that today I’ll show you how you can quickly and easily get a handle on your money management, so that you can be confident that you will never stumble into this pitfall.
Understanding the nature of the beast
If you want to beat the markets, there’s something important that you need to know about the nature of your opponent.
He doesn’t move in straight lines.
Trading is about cycles. I’m not just talking about good days and bad days – I’m talking about good years and bad years.
You need to keep your cool and be patient – chip, chip, chipping away at the markets, instead of trying to take a huge glancing blow.
The pitfalls
1. Many, many novice traders are risking 10% … 15% … even 20% on any one trade. If you’re trading at these levels, I guarantee – that’s right, I 100% guarantee – that you will get wiped out.
Perhaps not today … perhaps not this year … you might get lucky and make some good profits along the way …
But sooner than later, a bad run will come along and clean you out.
2. The other mistake I’ve seen traders make is to decide how much money they “want” to make – and to calculate their stake size from that!
3. And finally, if I had a penny for the number of times I’ve spoken to novice traders who’ve mistaken their “stake” for their “risk” – I’d have … well, probably enough to buy a pint.
Don’t let it happen to you
There is a simple and obvious answer to the problem of losing too much money on a losing trade. See if you can spot it …
A. Avoid making losing trades.
or
B. Don’t risk too much on any trade.
While it would be nice to think that answer A. was a possibility – it isn’t. All traders lose. Talk to any extremely successful trader, and they’ll tell you that they’ve lost many, many times.
The correct answer, of course, it B.
Most professional funds risk less than 0.25% on any one trade.
Of course, these big boys have the advantage of enormous funds and many hands working for them.
For us lesser mortals, we have to accept minimum stake sizes and the limitations of a one-man band, so a more realistic maximum to set would be 2% risk on any one trade.
Managing it
There is never any reason to be in any doubt about what your stake should be.
If you’re dithering over the “stake size” box – you’re not ready to place a trade.
You simply need to know how much you’re willing to risk – and how much you have in your fund.
If you’ve a trading fund of £5,000 and you’re willing to risk 1% of that on each trade, this is what you’ll need to do …
1% of £5,000 is: £50
If your trade demands a 20 point stop limit, you could potentially lose 20x your original stake.
Therefore, your stake size should be £50 / 20 = £2.50
It’s that simple.
All you need to do is this quick calculation before you place any trade. (Don’t worry, there’s a full checklist coming up.)
Dealing with a drawdown
As traders, we don’t much like thinking about losing trades. And we like thinking about losing runs even less.
However, they happen to everyone. And they will only damage your trading career if you haven’t prepared for them.
If you let your losses build up, you’re creating an uphill battle for yourself.
Let’s say that you’ve lost 50% of your trading fund – you’ll need to make a 100% profit on that just to break even. It’s a tall order.
Beyond control of your stake size, one of the best ways to manage your risk is to stop trading.
Don’t worry – I don’t mean pack it in altogether.
What I’m talking about is setting yourself, each day, a maximum profit target and maximum allowable loss. When one of these is hit – you stop trading.
And by setting your maximum daily profit target above your maximum daily loss – you’re already putting yourself at a statistical advantage.
Let’s say that my maximum profit target in a day is 6%. If I hit that – I stop trading. I’ve 6% pure profit tucked into my fund – and won’t take any more risks with my capital that day.
And if my maximum loss for a day is 3%, and I hit that – again, I stop trading. What I don’t do is go on and on, trying to recoup those losses. Instead, I lick my wounds and live to fight again the next day.
You can also set yourself maximum profits and losses for a year, and monthly. That way you can ensure that your losses don’t grow and grow until you suddenly find yourself 50% down (or worse) at the end of the year.
The trick with trading the markets is staying alive – if that means lying low for a while, then so be it.
YOUR MONEY-MANAGEMENT CHECKLIST
(examples in brackets)
1. Have I hit my profit target for the day/month/year? (No)
2. Have I hit my maximum loss for the day/month/year? (No)
3. What is my account balance? (£18,387)
4. What percentage am I risking? (1%)
5. What is my stop loss on this trade? (35 points)
6. What is my risk amount? (£183.87)
7. What is my stake size? (£5.25)
I hope you already have the answers to these 7 questions at your fingertips. If not, it will should only take a few moments to work out – and it can make a world of difference to your trading success.
Until next time,
Mark Rose
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6 comments
Mark Rose
Hi again Daniel,
You’re right when you say that the more trading you’re doing, the more complicated your money-management becomes. If you’re trading many many times each day, then you won’t want to be risking 2% on each trade. (As I explain above, professional funds risk less than 0.25% on a trade.)
In terms of whether or not you need to trade every signal or not for your strategy to be valid, I think you need to be careful. There needs to be a balance between blindly following rules, and keeping a handle on your risk. They needn’t be mutually exclusive – money management should be worked in to the rules of your trading strategy.
Mark Rose
Hi Daniel
You make some really interesting points there.
First off, I don’t believe that you have to trade every single set-up. If you hit your profit target or loss for the day, and stop trading, that doesn’t mean that you can’t valuably spend your time collecting data for the other trades that day (just paper trading) – this really isn’t wasted time, and can give you sound information about the best times to trade.
Obviously, I don’t know anything about your strategy, but most systems have an optimum time of day that works best. And sometimes it’s really important to just sit tight. If you use the kind of daily profit targets/max loss limits that I talk about, you should never find yourself in the position of risking 40% in one day.
I do agree with you that it’s good to have a few strategies on the go at any time, but watch out that some of these signals aren’t duplicating each other. For example, if you’re long on the Dow Jones and the S&P at the same time, you’re actually doubling up your risk. It’s great to diversify across a few strategies, but don’t use so many that you lose track of these risks.
I appreciate that some traders are very active, and others less so – it can be difficult to be specific to everyone’s needs in my weekly bulletins. I hope that helps.
Mark
Daniel Simion
Hi
Thank you for your reply.
An example of a simple strategy can be a breakout momentum strategy wich give an average of 5 signals by day. If I take a loss on my first 2 trades of the day and I stop trading for that day, the following 3 trades for that day can be winners. If I would took all the signals that day, I would be in profit. I didn’t and I have a loss for the day. I can’t see the utility of paper trading for the rest of the day, it will only add confusion.
The success rate of a strategy means something only if we take ALL the signals. That’s how a strategy is tested, by testing all the signals that it gives. If we ignore some signals, the success rate means nothing and we can only hope that we are lucky and take the winning signals and ignore the loosing ones.
Daniel
Daniel Simion
Hi again,
I would like to add a few points more :
– I agree that a strategy has optimum times of the day when it works better; this is something that we study before we begin trading this strategy and we establish rules for the strategy that take care of this, for example “the setup must not be traded between 12 am and 2 pm”. But this is a RULE that is pre-determined.
– the 2% by trade is valid if we take only ONE trade by day. This is hardly profitable on the long term. If we take more trades by day, the risk is multiplied and the money management becomes more complicated : how many strategies ? should we divide our capital in small parts for each strategy ? what if we take trades for a same strategy but different trading instruments ? … and so on…
Thank you for your patience.
Daniel
Daniel Simion
Hello
There are 2 problems in your explanations :
– we trade a specific setup; this setup has a rate of success, say 60%; if we stop trading after reaching the profit target or loosing target for the day, then this 60% success means nothing : we can missed some winning trades and take the loosing trades, so this becomes pure gambling. A specific setup must be traded all the time and take all the signals, if not is gambling.
– you say to not risk more than 2% for each trade. This is OK. But how many trades we take a day ? Someone who takes 20 trades by day has a potential risk of 40% by day; someone who takes only 2 trades by day has a potential risk of only 4%. The amount of risk per trade is the simple part of the money management. Far more important is how many strategies we trade on same time and how many trades we take by day. The big problem with this is that we MUST trade several strategies (the more we trade, better it is). Strategies work only for a while, not for ever, so we can replace the ones that don’t work any more with others.
Can you give me your opinion on this ? (sorry for my english…)
Thank you
Daniel
dsimion@pt.lu
Dave
Hi Mark
Very useful,and helpful comments,it all makes sense,and a copy should be kept to hand by seasoned,and newbie traders alike ?
keep up your good work
Dave