Money management may be the most important skill that you can learn to succeed at trading the markets and financial spread betting. How you view your trading account, and how much you risk on each trade is critical – and the use of stop orders is central to this concept. The key ingredient to successful trading in the long term remains one’s ability to preserve capital and thereby stay in the game. If you keep doing this over time, the winners will more than compensate for the larger number of smaller losing trades.
“Trading is about protecting your capital…NOT maximising your profits. Many traders spend too much time setting up their entry points but position sizing, exit methodology and discipline are at least as important as getting the timing right”
Remember the unexpected will always happen at some stage, but we must focus on what we can control e.g. stops, targets, appropriate risk etc.. Events like 11/9 and 87 crash will always happen. Here’s a few things I have learnt over the years -:
- Agonise over my position before entering a trade not after.. e.g. figure out buy price, stop price, how I move stops up before entering, then once in just follow the plan.
- Over years have missed out on endless thousands, due to not following the plan and think I know best and exit for a supposed good reason, but had I followed my original system would’ve made more…
- Once in a position and stop in place don’t keep looking at it as tempted to micromanage..
Money management refers to how you choose to allocate your money to different bets. You have learned a lot about picking the trades that have the best chance of success, but the best estimates say that money management accounts for 30% of your results. Incidentally, in the same estimates they say that your choice of when you enter and exit the trade accounts for only 10% of your results, and the remaining 60% comes from the psychology of trading, and how you handle your emotions.
Money Management and Position Sizing
Some traders tend to focus their analysis on finding the perfect entry price point for their spread betting positions. Whilst this is important, two equally crucial elements in trading are your stake size and the price at which you plan to exit the spread bet. The other term used in trading circles is stake or position sizing, which refers to how much you place on each bet. Once you have found the trade you want to take, you still have to work out the right amount to bet so that you do not risk losing too much. It comes from your analysis of the trade, and where you fear the price may be going if it turns out to be a loser. This is your stop loss calculation, bearing in mind that unless you take out a guaranteed stop losses you can lose a little more than where you set the stop.
Planning profit targets and stop loss levels should be at least as important as your entry level as it is the point at which you exit a trade that determines your net profit or loss. Deciding on managing your trades in this way also helps you to manage your trades when you are away from your screen as it means that you don’t need to be constantly monitoring your spread bet. Limit orders play an important part here as they serve the purpose of automatically closing a profitable trade once the market has breached a trigger value set by yourself.
For instance, if you opened a long position at £5 per point on the FTSE 100 at 5150, and then set a limit order to 5250, you would automatically stand to make a gain of £500 (5250-5150 x £2) should the index then reach 5200, irrespective of whether or not you were monitoring the trade at the time.
“As Vince Stanzione puts it a good trader does not necessarily need to make money every single time. ‘You could get 80 per cent of your trades wrong and still make an overall gain. Suppose you lose £100 on eight trades and then make £500 on two trades, you are still in profit. However sure you are that the market will crash or ABC stock is going to soar, make your first trade a small one, and then, if you are correct, add more to that trade.”
Money Management Approaches
Unfortunately the money management facet of trading systems is perhaps the most underrated aspect of stock market trading. Most spread traders prefer to focus on finding an edge in the market – like a profitable trading system or trading method but the biggest opportunities for profit are often found in methods for applying an existing trading system or method. These are often referred to as money management methods, such as position sizing.
There are various money management approaches such as:
The simple stop loss (that should always be implemented)
Pareto Rule: 80/20 rule
Martingale and Anti-Martingale
Fixed Ratio Position Sizing
Fixed Fractional Position Sizing: Two percent rule
Position Sizing Optimization
Monte Carlo Analysis
Equity Curve Trading
Here are some proven guidelines. Once you have some experience, you can choose to stretch or ignore them, but they’re designed to keep you out of trouble and keep you in the game.
Firstly, remember that spread betting can result in a margin call if you allow or are caught out by heavy losses. You need to keep some funds in reserve so that you can satisfy this, and should plan to commit a maximum of 50% of your funds in active trading, so you have something to fall back on.
Secondly, you should be realistic about the amount you can lose on any particular bet. Remember, this is calculated from the stake and from where you position the stoploss compared to the entrance level, with an allowance in case the stoploss level is missed. You really want to limit the possible loss to a maximum of 2% of your trading account. This may sound low, but if you have several losses in a row, perhaps followed by a winner then a few more losses, you will find that 2% should keep you viable, and a higher percentage would cripple your account. You need to preserve your capital so you can keep on spread betting. Some professionals don’t even risk this much.
If you are still not convinced, it’s worth thinking about the way percentages work against you when you are losing. If you lose 20% of your account, then you need a profit of 25% to get back to where you started. If you lose 50% of your account, then you must gain 100%, or double your money, just so you can begin again with the original amount.
I have already mentioned the need for a stoploss order every time you place a bet. Some people do not like doing this, particularly as spread betting brokers generally set their own prices, and therefore can manipulate them to trigger your order and close you out for a loss, even if the financial security is heading in the other direction. However, it would only take one time when you were distracted from watching the markets and the security plunged for you to lose a significant amount. So on balance, unless you find a lot of trouble with your broker, it is worth setting the automatic stops.
“The number one job as a trader is that of risk manager. Amateurs take risks that would make professionals cringe. The fact is that they too were once amateurs. They probably frequently look back upon the risky mistakes they made, brought on by greed, which in the end brought on no more than heart palpitations and a lighter bank balance. Because greed is a typical trait of the casual market participant, he or she either ignores or is unaware of the risks being taken until it is too late. This is a key realisation which you’ll need to cope with early on”
To conclude financial spread betting can be an exciting and profitable way to trade the markets. However, it carries a high level of risk and the most successful traders are sensible enough to take the time to learn the mechanics before making any significant bets. Risk management and careful monitoring are crucial if you want to increase your chances of success.