I recently received an e-mail from a subscriber who set out his
plan for money management. In general, he made each trade 10% of his
capital and found that about 60% of his capital was in trades at any
given time. I applaud the subscriber. Not particularly because of the
brilliance of his plan, but because he took the time, made the effort,
and understood the need to have a money management plan. Could he have
chosen a different money management plan? Of course, he could and, at
least as far as I know, there is no perfect money management plan. Some
advocate making each trade 3% or 5% of risk money (that's my personal
plan), others advocate equal dollar trades, and yet others may say limit
losses to 7% or 8% of your trade.
Any of these methods can work. One of the keys is to stay in the
game, and money management helps us do just that. If we have no plan to
manage our money, we may throw a small amount into one trade and a large
amount into another. Suppose Trade A was allotted $1,000 and Trade B
allotted $10,000. Trade A turned out to make a 20% gain and Trade B
resulted in a 10% loss. We would have made $200 on Trade A but lost
$1,000 on Trade B. See the diffference if we had made equal dollar
trades, i.e. each trade $5,000. In that instance, we would have made
$1,000 on Trade A and lost $500 on Trade B.
Unfortunately, we may think we know which trade is going to be the
blockbuster, but the fact is, no matter what we may think, we never can
know which trade is going to be the good one and which trade is going to
go south until the trade is over. We can help deal with that issue by
using a money management plan.
Money management is not the only area in which we need a plan when
trading. As the saying goes: "Plan your trade and trade your plan." In
my estimation, we should formulate our own personal trading plan before
we ever enter a trade. It should include things like money management,
what strategy we will employ, when we will enter, when we will exit, etc.
The very existence of a plan, no matter what the plan is, is a
significant aid in removing emotion from our trading. Though it has
often been said (and certainly seems true) that fear and greed move the
markets, we are better able to profit if we can remove those emotions
from our own trading and learn to benefit from those emotions in others.
Plans are helpful in removing those emotions and they give us a
framework in which to operate. However, we must be careful to remember
that none is infallible. I understand and accept that my plan will not
work every time in all situations. I know I will have losing trades,
but I am confident that I will profit overall as long as I follow my
personal plan. If I perceive weaknesses in the plan, or find
improvements, I can always alter the plan.
If I had no plan, how would I proceed? How do you proceed? It
seems that without a plan, we can only act "as the spirit moves us," and
that translates to me as following my emotions. I suspect that nothing
can be more dangerous to a trader.
Good Trading!
Bill Kraft
Mr. Kraft's past articles are posted on our website for your review.
