November 29, 2009
Money Management Explained
One of the most important and often overlooked aspects of trading the stock market is money management. If you are correct with your forecasts, your overall profits will not be great unless you implement a proper money management plan.
The amount of money you invest on each trade and how you manage your capital is a critical part of money management. You should also compare the amount of money you expect to make to the amount of money you intend to risk. There are certain orders you can place with your broker that gives you the opportunity to manage your trades automatically, such as stop loss orders, trailing stops and limit orders.
Many people use position sizing on their trades. This controls the size of your position; on average, your risk should not exceed 2% on any one trade. You should also consider what you are willing to lose against what you expect to make per trade, this should be a positive amount. If you expect to make $200 on a trade and are willing to lose $50, this is a positive expectancy. Therefore, you can have three consecutive losing trades and still come out profitable on the fourth trade.
Stop loss as the name implies, automatically closes a losing trade at the level set by you. Unless you are watching the market minute by minute, it is always prudent to put a stop loss order on all your trades. Many things can suddenly affect the market so having a stop loss in place can preserve your capital.
It is also a good idea to consider a limit order on your trades. This type of order simply closes your winning position when the price has reached a target level set by you.
You have probably heard it said many times, that to be a successful trader you must cut your loss and let a winning position run. The majority of traders do exactly the opposite. One technique you can use to prevent this from happening is to use a trailing stop. This method is like having a stop loss and limit order in place at the same time. If you open a position and the market moves in your favor, a trailing stop moves up with your position at a certain distance away from the actual price. The trailing stop automatically closes the position when the price reverses. This method locks in more profit for you as opposed to using just a stop loss or limit order.
The techniques mentioned above are now part of many successful trading systems and should also included in any technical analysis strategies you use.
About the Author
Cole Anderson is an experienced trader and writer. More information on trading strategies and information is available from Cybertec Security