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- Money management in trading: the 3 rules to follow
Money management is one of the fundamental factors for building a winning trading strategy, especially in situations where high leverage is used, as often happens in forex. So let’s see the main rules to be adopted for the correct management and allocation of the capital to invest.
The rules of money management for earning money with trading are common sense indications, which unfortunately are not always followed in daily trading by most traders. As I wrote in the article “How not to lose money with trading“, self-discipline is very important in this sector: follow these fundamental rules for money management and, if you combine them with a continuous study of the market, you will have a lot of satisfaction.
Money management rules for trading 1: don’t be undercapitalized and risk small fractions of capital to last a long time
It is important to have adequate capital to trade and not to take excessive risks. This principle helps you survive long enough to be able to thrive. There are numerous examples of traders with small capital who were “eliminated” quickly at the beginning of their career.
Risk in each trade only a small percentage of the available capital, preferably no more than 2-5% of your portfolio. You can build up fortunes in the long run even by trading only 2-3 contracts at a time. The important thing is to survive long enough to continue working on the market, without being “wiped out”.
Money management rules for trading 2: use real stop losses
Using real stop-losses means inserting them immediately after taking a position on the market: “mental” stop-losses don’t work! Keep the maximum drawdown low (20-25%) and limit the risk of your entire portfolio to a maximum of 20%. In other words, if you were to suffer stop-loss at the same time in all the positions you had taken, make sure that 80% of the starting capital still remains.
Keep a risk / reward ratio of a minimum of 1: 2 and preferably 1: 3 or more. In other words, for every pip away from the stop loss, aim for 2 or 3 pips for the take profit.
Never add positions to positions that are at a loss (average down). If you find yourself on the wrong side, against the market, admit it quickly and close the position. Your EGO is often detrimental to proper trading.
Money management rules for trading 3: block part of the earnings
Try to block a portion of the earnings you are making. If you are lucky enough to take a substantial move in a short time, liquidate at least part of the position (by moving the stop loss into positive territory for example).
When you suffer a series of consecutive losses, stop and re-evaluate the market and your working methodology, the market will always be there waiting for you. Gann summarizes the concept in his book How to make profits in commodities published more than 50 years ago: “When you make a series of consecutive losses, small or large, there is something wrong with you, and not in the market . The trend may have changed. My rule is to go out and wait. Study the reason for the losses. Remember that you never lose money by being out of the market”.
