Money Management

Congratulations! You now have a great deal of knowledge about technical analysis, whether you have committed it to memory or simply know where to look for details when you want them. That alone will not make you one of the winners in the spread betting field, but it’s better to know how to put the odds on your side whenever you bet. In fact, that’s all that technical analysis can do, despite what a few people claim, as no-one knows where the markets are going next. People have even analysed the different indicators and patterns, to see how good they are. My colleague Greg Morris, who is another candlestick expert who has been around almost as long as Steve Nison, has compiled a massive reference work on patterns and their probabilities. It might say, for instance, that the probability of a reversal when you see a “piercing line” is 69%, and when you see a “bullish engulfing” pattern 78% (I just made those up, as I don’t have his book to hand). The point is that you never bet the mortgage or your life savings on any particular deal. Some win and some lose. How you bet is just as important, or perhaps more important, as knowing which are the high probability trades.

Which brings us to the topic of this section, money management. The guidelines we will be looking at are generally applicable to all types of trading, not just spread betting, but you need to take account of the type of financial instrument you are trading as the leverage, or gearing, varies with derivatives, Forex, futures, etc. Another way of referring to money management is as risk management – how much and in what way are you going to risk your money so that you don’t run out of money after an unlucky run of losses, which do happen from time to time.

What we have looked at so far is how to pick the higher probability bets, which if you do it consistently should have you coming out on top – or should it? Well, not necessarily, as it also depends how much you are likely to win if the bet is good, and how much you let yourself lose if the bet goes down. You have to take all this into account to become a good spread better. “Cut your losses and let your winners run” is an important traders’ saying, and you must develop a way of looking at your bets to assess whether they are worth taking.

If you are unsure about this aspect of betting, then just think of it in this way. Suppose I told you I would have a bet with you, and the chances of your winning were 95% – would you bet with me? I expect so. But if I went on to say that when you won, I would give you 10 pence, and when I won, you would pay me £100, I don’t think you would want to bet any more. And on the other hand, if I wanted to bet with you and told you that you would only win one-third of the time, you would be slow to take me up – that is, until I revealed that I would pay £50 when you won, and you would only owe me £5 when you lost. So probability of winning is just one factor, and you must look at the whole picture.

One guideline used by many successful traders is that you only risk losing 2% of your account on any one bet. Sounds pretty small, doesn’t it? But just think about the consequences of a string of bad bets if you were losing, say, 10% per bet. One statistical quirk that works against you is that you need to make much more, percentage wise, to make up any losses. I’ll explain with a couple of examples.

If you lose 10% of your account, then you only have 90% left. If you want to get back to where you started, you need to make more than 11% on the remainder. That doesn’t sound too bad, does it? But then, if you lose 20% of your account, you need to make 25% on the remainder to get back to your original amount. It gets worse. If you lose 40% of your money, you need to make 67%, and if you lose 50%, why you need to make 100%, or double your money, just to get back your stake. It’s not impossible to have five losses in a row occasionally, and if you were losing 10% per bet, you would really be setting yourself a difficult task to get back in the game.

In fact, you can find professional traders who think that losing 2% on a trade is far too much to risk, but it is usually considered okay by the majority. As you develop the experience, you may want to pick your own percentage.

When you are spread betting you must understand how much you are really likely to lose. It’s not quite as straightforward as simply buying a stock, and then seeing what percentage the price changes. An integral part of assessing your possible losses is knowing when you are going to say that enough is enough, if the bet goes against you, and close the position. This is something that you will learn to always calculate before you put any money up at all, at least if you want to be successful. Any bet, or trade in general, must have two exit levels before you even place it – one is where you expect the trade to go for a profit, and the other is when you have decided that it is not going to do what you want, and you must close at a loss.

This brings us to the next calculation you need to do before betting. That is an assessment of how much you expect to gain, with a reasonable movement say to an expected resistance level, compared to how much you could lose before calling it a failure and getting out. Some traders say that you can figure on a two to one ratio, that is you expect to get twice as much as you think you would lose, and other traders stick to a three to one ratio. To some extent, you may have to set the ratio by the type of trading plan you have.

It’s important to think what this means. It means that you can even lose more often than you win, and still turn a profit. Of course, you have to be good at figuring the ratio realistically, and that can be difficult, but if you practice and get to know your market, then the rewards are great.

The opposite of this is also true. If you see a bet that pays less than two times what you would lose if it didn’t work, then you probably should ignore it. Remember that you are not losing any money by not taking a bet, and there will always be another one. It’s tempting to ignore this rule if you think that the bet is a “sure thing”, with all indicators and patterns telling you to make it – but you can be looking at the same data interpreted in different ways, when your mind is telling you that they are independent indications. It’s human psychology. Discipline is an important part of making a profit, and you will find that your instincts can work against you – this may be the hardest lesson that you have to learn.

When you are spread betting, it’s not the same as some other trading. You are betting on margin, and it is up to you to keep an eye on your positions and the margin, to make sure that your bookmaker doesn’t have a problem with a lack of funds. In fact, if you ever get a margin call against you, you need to draw back a little and see where you are going wrong. It means that your account is looking too sparse for the risks that you have going, and the dealer is within his rights to protect himself by closing your open positions if you are not quick to respond to the call.

This is a really bad situation to get into – the dealer will close whatever bets he needs to, and that surely won’t be the ones that you would have chosen to close first. After all, who would you rather selects the positions to be closed, if it comes down to that – you or the bookmaker? The alternative to closing positions will be to quickly put more money into the account, and that isn’t always easy to do right away.

As previously mentioned, as part of your trading plan, and wise money management, you should always have two exit values for every bet – one for when it goes right, and one for when it goes wrong. While you are winning, and you can see the trend continuing, of course you may plan to keep the bet open past the exit point. In this case, you will probably adjust your stop loss, whether an actual order or just written down, so that your gains are protected. If you are losing, there is never a good reason to ride the trade down further than you planned – if it is hard to quit the losing position now, just think how much harder it will be if it continues down and you lose twice as much.