Once you have attained a good appreciation of the basics of trading, irrespective of whether your preference is stocks, currencies or commodities, then acquiring a thorough understanding of money management will be vital in determining just how successful an investor you will become. You need to realize that your trading performance will be greatly enhanced by merging a well-tested money management strategy into it.
So what is money management? Basically, this tool can be regarded as a statistical methodology that can help you evaluate just how much you should wisely risk per trade. For example, many experts recommend that investors should master a simple but very effective money management strategy that is based on risking a pre-determined fixed amount of their total account balance per position. Specifically, they advise that a maximum value of just 2% should be applied.
You can gain an appreciation of the logic behind this approach by realizing that there is a serious difference between risking 2% and 10% of your total equity per trade. For instance, if you were to risk just 2%, then you would lose only about 17% of your total balance should you be unfortunate to endure ten consecutive losses. Under the same conditions, you would experience losses of about 66%, if you risked 10%.
From studying this example, you can conclude that using a lower level of risk per trade will certainly help optimize the protection for your account. You will also buy yourself time to evolve your skills and knowledge about your new profession by utilizing such an approach. This type of money management strategy complies with the principles of an important trading maxim which emphatically states: ‘Do not risk too much of your balance at any one time’.
If you learn to adhere to the above advice carefully then you will greatly improve your chances of advancing your trading skills and knowledge in small steps of incremental risk whilst ensuring maximum protection for your account balance. You can keep your risk per trade within this specification by accurately calculating the precise stop-loss and position-size of each trade you enter. Your stop-loss specifies the number of pips that you are prepared to risk per trade while your position-size represents the size of your trade, which is usually expressed in lots.
Unfortunately, most novices completely fail to grasp the importance of a powerful money management strategy and, as a consequence, a large majority of them fail. In contrast, your top priority as a trader is to safeguard your equity because without it, you will not be able to trade any further without making additional deposits. This is an undesirable habit that you must learn to avoid at all costs.
However, human nature will prompt you to concentrate on profits as opposed to focusing first on potential losses. In addition, you will discover that most novices suffer from a psychological tendency in believing that all their trades will be winners. Consequently, they are completely unprepared to content with horrendous problems, such as a series of consecutive losses.
As all types of trading are complex, you must quickly understand that losses are practically inevitable. You must therefore appreciate that prosperous traders are those that perfect the skill of controlling their losses by managing them effectively. This is why you must devise a money management strategy which is a policy that will permit you to minimize your risk exposure and maximize your profit potential.
Achieving this objective is crucial in order to acquire financial success especially because of the high leverage and volatility involved during most forms of trading. Always remember the trading maxim that states: “Take care of your losses and your profits will look after themselves.”
Bear in mind that trading is about assessing odds and that you only possess total control of your equity until the moment you enter a new position. From that instance onwards, price becomes king which implies that you will never precisely know whether your trade will eventually produce a profit or loss. However, you do always have the ability to determine by utilizing a well-tested money management policy, the maximum losses you could incur should price move against your open positions.