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Soultrader

Money Management: The True Holy Grail

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One of the top trading secrets is money management. All traders have heard of it and some may think they actually know it. But how many traders practice sound money management?

 

Most traders lose mony because they lack money management, do not have enough knowledge of the market they trade, do not have a sound trading methodology, and trades a market that does not fit their style.

 

If the average win per trade is greater than the average loss per trade, a 50% winning trading setup can make you money. But excess risk, greed, poor psychology, and the failure to understand probabiltiies can take an account with a 60% winning methodology to ruins.

 

There are several money mangement models. In this thread, Im going to discuss just the basics of account sizing and peek-to-trough drawdown.

 

Alot of new traders fail get into the trading business hoping to make a million by the end of the year with a $5,000 to $10,000 account day trading. This is an unrealistic goal. Day trading is a business of grinding profits everyday. Consistency is the key to survivial and learning to ring the register often. One of the main reasons why new traders go bust is their account size. A $5,000 to $10,000 is too small to practice sound money management. A 10 point YM loss is equivalent to $50 per contract. $50 is 1% for a $5,000 account. 3 losses a day and a trader has just lost 3% of his account. Now 3% may not sound like a big deal but take a look at the data below:

 

mmpercentages.jpg

 

The percentages really start to change after a 30% drawdwn. A 50% drawdown requires a trader to double up just to break even. A gambler mentality tells a trader to double up his position to make back a loss. This is one of the worst habits a trader can have. Frustration and lack of emotional control will cause a trader to double his size on the next trade in hopes to break even. At first this may work, but it leads to bad habits and will lead to bust.

 

 

Peek-to-trough Drawdowns

 

Let's say you are a fund manager managing other peoples money. Your initial fund size is $500,000. In the first month, you managed to increase the $500,000 to $750,000 for an impressive 50% gain. Now the next month you dont have any good trading signals. However, your portfolio goes down to $600,000 in value. You have not made a single trade that month, however your accout has gone down from $750,000 to $600,000. the peak-to-trough drawdown would be (peak = $750,000 and trough = $600,000) $150,000 or 20%. This has occured without a single losing trade that month.

 

Your clients are only concerned about this 20% drawdown. If they simply withdrew their money the month before, they would of been $150,000 richer. The third month, your $600,000 account goes down to $525,000. Thus the peek-to-trough drawdown is now $225,000 or 30%. From industry standard, your annual rate of return of is 5% (up only $25,000) with a 30% peek-to-trough drawdown. This data will label you as a terrible money manager.

 

In calculating risk vs reward, we need to look at the peek-to-trough percentage. If your annual rate of return is 5% a year with a 30% peek-to-trough drawdown, your risk-to-reward ratio would be 5/30 or 0.166. This is a terrible ratio. Make sure to keep this in mind when day trading. Although at the end of the day you may have been up, what was your drawdown? If you are trading with a $5,000 account and your account goes back and forth from $4,500 to $5,100, are you practicing good money management? Do you have good trading strategies and setups? Is it worth the stress of seeing your account fluctuate to $4,500 just to make $100?

 

I hope this makes sense. Money management is everything in trading. We are in the business of risk. Happy trading :)

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Technically, if you were to limit risk to 5% per month, and you were receiving interest on your account balance of 5% or so, which isn't very hard to get right now...(maybe it will be soon if the rates keeps dropping) wouldn't you essentially be guaranteed to almost break even if you never had a winning trade, but capped your max risk?

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Technically, if you were to limit risk to 5% per month, and you were receiving interest on your account balance of 5% or so, which isn't very hard to get right now...(maybe it will be soon if the rates keeps dropping) wouldn't you essentially be guaranteed to almost break even if you never had a winning trade, but capped your max risk?

 

Reav - that 5% interest you are talking about is ANNUALLY. I doubt there's many brokers paying 5% monthly. So, if you risk 5% per month and let's say lose in 1 month, the ANNUAL interest will cover some of it. Keep in mind that since that 5% is paid annually, it is paid on the revolving balance - if the balance goes down, so does your interest.

 

As a side note, very few futures brokers pay you interest on money parked with them.

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Martingale, Anti-Martingale, Fixed ratio, Fixed Fractional, Kelly...

Does anyone use these ideas or are most people here trading one lot, or small?

 

How do you trade less than 1 lot?

 

;)

You have a valid question and I don't know what the answer is. To get a whole bunch of guys on forum about trading to tell how many lots they trade would be a stretch at best. And even those #'s would not be accurate - kind of like when you ask a girl how many guys she's slept with - the rule is multiply what they say by 3, right? Same idea here, but probably need to divide.

 

:roll eyes:

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Number of contracts doesn't matter so much, the methodology for scaling up or down based on - what - is the question.

 

In my testing, fixed frational seems to have the least relative drawdown.

 

I have done testing on Ryan Jones' fixed ratio and it jumped my system from 1 contract to 18. Yeah it ended up winning, but whoa!

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If you are trading more than one contract, Brown, how do you decide when it is time to scale up to the next level? Do you use a formula?

 

The 'formula' I use is rather simple - trade 1 contract per $x,xxx in account. That's it. I know there's many fancy formulas out there, but based on my recent trading activity I will decide how many contracts to trade. More of a - strike while the iron is hot mentality.

 

I think the fixed number is easiest. As you make money, you trade more. If you are losing, the last thing you want to do is add more contracts. I would suggest that you trade one ES contract for every $2500-$10,000 in your account if daytrading. I give that range b/c like I said - if you're new and struggling, one contract is plenty. If you are cranking, then add more. That also gives you a goal to shoot for. If you know that you will add when you make $5000, then you need to figure out how can you make $5000 and then track that progress.

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Reav - that 5% interest you are talking about is ANNUALLY. I doubt there's many brokers paying 5% monthly. So, if you risk 5% per month and let's say lose in 1 month, the ANNUAL interest will cover some of it. Keep in mind that since that 5% is paid annually, it is paid on the revolving balance - if the balance goes down, so does your interest.

 

As a side note, very few futures brokers pay you interest on money parked with them.

 

First of all you have to entrust people (if you are going to give money to other people), but I am sure that MM is a very important in trading... As for me, so I trade using 10% of my deposit... but if you are using a big part of your deposit, so it is very easy to lose everything...

more that 10% can use only professional traders who can be sure in their risk.

 

And for all beginners, MM is a VERY IMPORTANT part of the trading...

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My rule for trading the YM is to trade one contract for every 5k in account. This is daytrading only, no overnight positions. Maybe a little too conservative????, but that is what I have set up. Being a smaller trader I can't imagine one contract every $2500, but maybe as I get more proficient and the account grows I will be inclined to ramp it up a bit. Right now I am just trying to build up, pay off debt and park 2-3 years worth of living money so I can go full time...

 

Stephen

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hi everyone,

 

Great Soultrader... i will must say it's a awesome post of yours'

 

thanks for the great technical information...

 

take care

 

 

 

_______________________________________

Edited by tradingwizzard

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