Discussion Topic: Money Management
Being successful in trading requires a lot of patience, a proper education, a number of other qualities. One of such other quality is Money Management. In this article, I will try to hit that bull’s eye. I will try to explain the top 15 money management tips for beginner traders. You can also read the concept of this article as effective money management tips.
Eventually, to win a trade you will need a comprehensive trading plan. A comprehensive trading plan will tell you when to enter, when to exit, which stocks/currency pair to trade, and most importantly how to manage your money.
What most traders fail to understand is that you should not only plan on making profit from a single trade, or simply acting upon on your exit and entry points. But you should also prepare your trading strategy on achieving gains over a long period of time.
What is Money Management?
Money Management is nothing but an art of managing your working capital by applying tight risk management. It is the most important exercise in trading after the trading psychology but beginners tend to ignore it and only focus on technical analysis.
However, in order to survive in the stock market, you must know how to manage your capital in real time. Before entering into a position, the first question you should ask yourself is: "How much risk am I taking on my capital?" Instead of "How much profit will I make?". The key is to always be pessimistic about your potential losses.
Because money is the ultimate necessary thing to survive in the market. If you lose all your money, your journey ends there.
What are the Rules of Money Management?
The rules of money management in trading are quite easy to follow if you can control your emotions. They also have the potential to save you from a lot of big losses if you follow them properly. Now let's go through the best money management tips for beginner traders:
1) Don’t Trade Too Aggressively
Too much aggressive trading is possibly the biggest mistake new traders make. This includes taking too much leverage, random entry & exit, taking too much risk on capital etc. If a small reversal of the market is enough to wipe out most of your risk capital, then you are taking too much risk. A better approach to aim for the correct level of risk is to adjust your position size.
2) Be Realistic at Time of Trading
Now, the reason for the new traders for being overly aggressive is mostly because of their non-realistic expectations. Mostly, they think that aggressive trading will help them to get a huge return within a short time. But the real facts are just the opposite. You should set realistic goals and maintain a conservative approach to get a steady return.
3) You Must Know Your Exit Points Before Opening a Trade
Determine the realistic levels you are aiming for before entering into any trade. i.e. - The target level you are aiming for and the maximum loss you can sustain. Doing so will help you to remain disciplined in the heat of the trade. It will also direct you to think a trade in terms of risk versus reward.
4) Placing a Stop-Loss is Must
One of the best money management tip for beginners is that you should use stop-loss of each and every trade. Money management is all about increasing your survival opportunity. And Stop-Loss will just do the same for you. Since there is always the possibility of a loss, you must set your stop-loss order not to exceed more than 3% of your trading capital, summing all running positions. I'll explain this point in-depth later in position sizing section.
Always remember that survival should be your highest priority and that profit comes second. But again you must choose stop-loss wisely so that it is not too small or not too large. If you found yourself in a position that your stop-loss always hits, then analyze your method of setting-up stop-loss levels.
5) Never Do Revenge Trading
The market is supreme and you should never mess-up with it. At some point of time, you may suffer substantial losses on your trading capital. At that time, it is natural to have a temptation to try and get your capital back with the next trade. This is called revenge trading and often this becomes fatal. Doing so will multifold your risk and at a time when your risk capital is already under stress.
Hence, never ever do it. Instead, consider reducing your position size and wait for a high-probability trade setup for form. Do not get yourself driven by emotions.
6) Be Always Ready for the Worst
We don't know the future of a market and also can't predict 100% correctly. Therefore, it's important to be prepared for the worst situation to occur and take adequate precautions to handle such situations. Think and write down all the actions you would need to take to protect yourself, just in case a bad scenario happens.
Never underestimate the chances of price shocks occurring - you must have a backup plan for such scenarios.
7) Determine Your Risk Capital
The first rule is that you should NOT bring more than 15% of the money from your savings in the stock market. Secondly, it is recommended to risk NO MORE THAN 3% of your active trading capital at any point of time during a day.
Measuring and limiting risk is a key aspect of money management. You need to calculate the risk involved in the trading process before opening any trade. Thus the size of your overall trading capital will be a factor to determine the maximum limit of your position size.
8) Use Leverage Wisely
Leverage offers the opportunity to maximize profits made from the available risk capital, but it also increases the risk of high losses. It's a useful tool only if you know the impact of leveraged exposure. Usually, brokers provide leverages on your account to enable you to trade for bigger profits. At the same time, your level of exposure to risk also increases with higher leverage. As a thumb rule, do not use more than 7x leverage for any of your trades. The less you use the better position you will hold.
Hence, you need to be extremely careful when using this facility. Use leverage only when you have a clear understanding of the potential losses if things go wrong.
[See Also: What is margin & Leverage? How to Use Them?]
9) Admit When You are Wrong
The golden rule of trading is to maximize your profits and cut your losses short. Therefore, it’s essential to exit quickly when you observe clear evidence that you have taken a bad trade.
It's a natural human tendency that to "not admit their mistakes" and try to turn a bad situation into a good situation. But unfortunately, it's not the best case for trading. Hence, if you found yourself in a bad trade at any time, exit from that immediately.
10) Have a Written & Established Trading Plan
You must have an established trading plan/strategy and you must adhere it in all situations. Your plan must include entry-exit points, position sizing, money management strategies etc. This will help you to keep your emotions under control and will also keep you away from overtrading. With continuous practice, this will bring discipline into your day-to-day trading style.
11) Recovering Lost Capital
You must keep it in mind, that the process of recovering lost capital is very difficult. For example, if you lose Rs.10000 by investing Rs.50000. The percentage of loss becomes 20%. So to cover that loss, you need to get a profit of 25% with the current capital. Hence, take risk wisely, so that it doesn't have too much adverse impact on your life. The below table will give you an idea that how much effort is required to regain lost capital.
|Drawdown||Recovery Capital||Recovery Effort|
|100%||0||Out of Market|
12) Use Trailing Stop-Loss to Maximize Profit
In addition to what I have told earlier about stop-losses, using the concept of trailing stops is also an effective way to improve money management. Once you start getting a reasonable amount of profit from a trade, you must book partial profit and advance your stop-loss to a stage that the trade doesn’t get into loss again. This way, even if the price starts to move in the opposite direction your trailing stop-loss will hit and you will be in net profit.
13) Don’t be Too Much Greedy
Greed is good but up to a certain extent. Don’t be too much greedy. Excessive greed may lead you to make poor trading decisions. Remember, trading is not about opening a winning trade every minute. It is all about entering into the right trade at the right moment and exiting such trades as per your strategy. Always try to trade in a disciplined way and follow money management strategies.
15) Read the Above Rules Everyday
We are humans and it’s our nature to forget everything within a small period of time. Hence, my suggestion is to take a print of this article and read it every day before the start of trading hours. By this way, you will be able to polish yourself to become a disciplined trader.
We hope that you have enjoyed the above article explaining the right way to manage your fund at the time of trading. Be with us to explore forex trading, stocks trading, and other money-making opportunities.
Leave us some comments if you have any questions or doubts about Money Management, we will be happy to help you.