Best Practice of Money Management

Best Practice of Money Management

Who hasn’t dreamed of getting rich by trading, like in The Wolf of Wall Street or in the movie of the same name? Everyone, right? Since the advent of Instagram and TikTok, and therefore influencers, we find all kinds of (bad) training on trading, which promise us financial freedom in two weeks by working 2 hours a day. It’s tempting but the trading world doesn’t work like that, let’s say you have a strategy that works, you still have to apply it to the letter and control your risks. This is exactly what today’s article is about.

The importance of money management

You’ve probably heard or read this saying somewhere: 90% of individual traders lose 90% of their capital in 90 days. Pretty scary huh? Experienced traders understand that success in trading is not just about a strategy that works, because any strategy, no matter how good, will go through a period of losses. This is a statistical truth and trying to hide it by “not thinking about it” or taking arbitrary position sizes based on our feelings would be a big mistake that would probably lead you to bankruptcy.

How to avoid this?

Stop-loss and take-profit

The first thing to do, of course, is to create your strategy by incorporating a stop-loss. This is the first mistake of a beginner, not putting a stop-loss because “as long as you don’t sell you don’t lose”. It’s a sure way to go bankrupt with a behavior like this. You must absolutely use a stop-loss and a take-profit in your strategy. Ideally, the ratio between the two, also called risk-reward ratio, should be higher than 1, but it also depends on the accuracy of your model. Indeed, if your risk-reward ratio is two, so with a take-profit twice the size of your stop-loss, you will need a little more than 33% success rate to be profitable. If your stop-loss is the same size as your take-profit, you will need more than a 50% success rate.

Position size

Position sizing is also extremely important in risk management because it allows you to risk only a fixed percentage of your capital. The level of risk will of course depend on your ability to take it, but generally speaking, between 0.5% and 1–2% per position is recommended.

Conclusion

These two practices, if you can stick to them, will allow you to endure periods of decline without too much hassle, at least in theory. In fact, it is precisely your discipline and control of your emotions, your ability to know how to apply the plan and not deviate from it that will be decisive for your success in trading.

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