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Manage It While You Can!
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by Rick J. Ratchford
My experience at the Futures West Conference this year was a positive one.
It was a pleasure to meet many trading personalities as well as fellow
traders as myself and discuss one of my favorite subjects...Making money
trading futures!
If I had to come up with one main subject that underlined the jest of what
most of the speakers there were trying to convey, I would have to say that
Money Management carried the greatest weight. Now, only one speaker really
went into depth on this subject, that being Larry Williams in his Keynote
Address. But it seemed to act as an impetus for this subject to pop up in
almost every other speakers outline.
Whether these were last minute changes prompted by their hearing Larry's
Keynote Address, or something they had originally intended to talk about
anyway, the bottom line is that they all recognized the importance of Money
Management in your trading plan.
It was very interesting to see the many examples that Larry and some of the
other speakers were providing to show that even with a system that is
so-so, you can make money with proper management. As a matter of fact, on
the flip side they showed that you could have an excellent system or method
and NOT make money in the long run if you do not exercise not only proper
risk management, but proper money management.
Let me separate the two for those who may not be familiar with these terms.
Risk management is more akin to determining how much you are willing to risk
and taking steps not to lose more than that. This is usually done by placing
stop loss orders in the market when you place your entry orders or shortly
after once you are in the trade. Some may do so with mental stops, which
take much more discipline, usually more than most traders possess.
Money Management is actually performing one or more calculations based on
how much is in your account, how much you are willing to lose on a trade or
how much drawdown your system is rated for, and the largest loss expected
ever for that system. The results are meant to help you decide on how many
contracts you should be entering with.
The damage most traders do to themselves is overtrade. With big eyes on the
pot of gold that is suppose to be at the end of the rainbow, they may put on
very lopsided positions which their account cannot adequately handle for the
long run. If a trader puts on more contracts than is mathematically
feasible, the results are devastating!
For example, if you have a $10,000 account and your risk is set to 10%, this
is $1000. If the max loss allowable per contract is $500, your maximum
exposure should be no more than 2 contracts. If you lose the $1000, your
next trade should now has a maximum risk of $900 (10% of $9000). Again, if
your maximum allowable loss is still $500, you now can only trade 1
contract.
The idea is akin to traveling from point A to point B, but each time only
going halfway. In theory, you will never reach B. For example, say the
halfway point to B is C. Now we have C to B. Now, go halfway again and call
it D. Now we are at D and need to go to B. Again, go halfway. See what is
happening here. If you only go halfway, you will technically never reach B.
So, if you always use just a percentage of your account per trade, you
should theoretically never reach $0. This is part of a good money management
plan.
Don't make the mistake of compounding the number of contracts you trade
because you lost on the previous trade and want to win it back. My father
was a compulsive gambler and each week he would lose his whole paycheck at
the horse races trying to win what he has lost over the years. Not only did
he lose everything, he was miserable and made everyone feel just as bad.
If you do not properly use Money Management in your trading, you are in
essence gambling. You are not looking at trading as a business, which is the
way you should be looking at it.
A formula was provided that works well for system traders. It goes like
this: Account Balance - Risk % (ex: 2, 5, 10, 20%) divided by the Largest
Loss rated for the system. The Largest Loss is usually the drawdowns the
system may experience.
Now, say your account balance is $20,000. You set your risk exposure to 20%.
If the drawdowns for the system is $6000, can you trade this system? No.
Why? Take 20% of $20,000 and you get $4000. Divide this by $6000 and your
result is less than one. In other words, you can trade ZERO contracts! Now,
say the drawdowns of your system or method is $2000 maximum. Divide your
$4000 by $2000 and you can trade 2 contracts.
Say you lose. Your account is now $16000. 20% is $3200. The next trade you
divide $3200 by $2000 and it goes into it one time. Say you find a system
where you will only risk $500 per trade. With $16,000 at 20% risk ratio, you
trade 6 contracts for $3000 maximum risk.
Now, you have to decide on what your risk exposure is going to be. The lower
the risk, the lower profit potential (and loss potential) you will
experience. However, if you enter only trades that offer at least 2, 3 or
more to 1 profit/loss ratio, and you win just 3 or 4 out of every ten
trades, you are going to come out way ahead! What his means is that you can
trade with almost any halfway decent newsletter advice and if you use proper
money management, you are going to make money, and lots of it.
Don't think in terms of how much you can make on each trade, but rather how
much you can lose. If you keep this in mind that you are going to lose, you
will be doing more to assure you stay in the game long enough for the wins
to put you ahead. Then, and only then will your account take care of itself.
Manage your account while you can!
cheers!
:)
rick
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