| Money Management Overview |
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Page 1 of 3 Money management is perhaps the most important aspect of successful trading. Whether you are a long-term trader, or a short-term day trader, money management is the difference between success and failure for most traders. This topic, however, is one of the most neglected topics in trading and investing. What exactly is money management? Every good trader has 3 main aspects to every trade:
Number One Trading Rule: Live to Trade Another Day! Every trader finds themselves in this situation at some point: We have a good stock pick, with high confidence of the stock's direction. Now, the question that must be answered: How large a position do I take? As you will see in the discussion that follows, this is the difference that can make or break a trading or investing portfolio. Let's examine a few examples to illustrate this principle. As a simplistic example, assume you allocate 100% of your portfolio to one position. You buy 100 shares of a $100 security for $10,000. If the stock declines to $90 per share, your portfolio is now worth $9,000. In order to get back to the original $10,000 portfolio value, you would require an 11% return. Likewise, if the stock declines to $80 per share, a gain of 25% is required. The table below illustrates this further for our $10,000 investment:
As you can see, a 20-50% decline in the portfolio value requires a significant return on investment to return to profitability. Here is where most traders and investors make their biggest mistake: As the losting streak continues, they increase the risk of their bets. In this case, that would mean taking larger positions in hopes of making up lost principle value. This is where amateur investors differ from professionals. The proper thing to do here is to reduce your bet size as the portfolio value decreases. Most of you are probably asking, Why? Click next below to find out. |
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