Warning … money and
portfolio management is the most important part of successful trading. We
are only going to touch upon money management in this section and we will
dive into it in the specific money and portfolio techniques in the money
management section.
Let’s define money
management:
Money management
evaluates the risk and reward of a trade and determines the best use of investment money. It tells
you how many shares to purchase and how much money to place at risk. It is
the difference between great trading performance and poor performance. It
will make the difference between making money and going broke.
Basically, money management tells you how many
shares stock to trade.
Some traders believe
that they are managing their money by having money management stops. Such
stops would get the trader out of a position when they lost a predetermined
amount of money – say $2,000. However, this kind of stop does not tell you
how much or how many so it really has nothing to do with money management.
Controlling risk by determining the amount of loss if you are stopped out
is not the same as controlling risk through a money management model that
determines the size of your position.
There are numerous
money management strategies that are available. In the money management
section, you’ll learn different money management strategies that work
well. Some are probably more suited to your style of trading than others.
Having said that, there are two basic
systems for money management that we need to be concerned about. We borrow these
systems from gambling
theory.
The first trading
system uses the Antimartingale system. This system has you increase
your risk when you win and it decreases your risk when you are losing.
This system does work and will the basis for most of our money management
systems.
The second is the Martingale System. This strategy increases money at risk during a
losing streak. After a loss, you increase the money on the next trade. The
assumption is that after a string of losses you will eventually win. And
the assumption is true- eventually you will win. For example if the
initial stock purchase was $1,000 and you double the amount to purchase
after every loss. When you do have a profitable trade, you will make
$1,000 from the entire sequence of trades.
However, a major
problem works against you when using a martingale system. And that problem
is called drawdown.
