3 Unbreakable Money Management Rules
Proper money management is imperative for success in futures trading, and there are several very common trading mistakes that will guarantee failure should you decide to implement them. It's not uncommon to see people engage in these account busting practices. To be sure, most unsuccessful traders engage in these practices on our regular basis.
I want to clarify that money management refers to the manner in which you manage risk in your futures trading account, not the way you manage your personal finances or pay your bills. The balance in your futures trading account is your lifeblood in trading, and safeguarding the stability of this account through best practices should be a priority for every trader. While several factors contribute to novice trader failure, money management would rank very high on the list of causal factors for failure.
While there are many rules that need to be observed in managing your futures trading account, I have selected 3 rules that cannot become part of your trading style. I consider these 3 rules of paramount importance.
1. It's not unusual for a trader to become convinced that he or she has found a great trade. Perhaps this setup has been successful for him or her in the past, and he or she believes that this setup is the recipe for guaranteed success. Of course, every good trader realizes that even the best set up has a probability component for success and failure. Good setups have a high probability of success, but that does not mean that a good set up cannot result in the loss. Oftentimes when a trader believes he or she has found a great trade and it starts to head south on him or her, there is a temptation to move his or her stop-loss limits down to accommodate the trade. It is imperative that you never move your stops to accommodate a market that is not going in the direction you desire.
When considering a trade, a trader sets his or her stops at a point that reflects his or her level of risk tolerance. When you move your stops lower, you are essentially expanding your risk exposure on a trade that is already going poorly. Does this make any sense? Of course not. The cause of this behavior is an emotional involvement to the trade, which is something no trader can afford the luxury of participating in. Some great setups simply don't work out the way they ought to; that is a fact of futures trading. It's important to minimize your losses and find a new and better trade, not to try to make something happen I have an existing poor trade. If a trade is not going the way you expected, move on to the next trade. Don't exacerbate the potential loss on a trade gone bad.
2. I routinely observe traders initiate trades without stops in place. Most trading platforms are capable of initiating trades with preset stops in place at the time you initiate the trade. You can set your stops as a bracket trade, or specify a specific stop and profit targets at a point where you are comfortable with the amount of risk entailed in that specific trade. My point is not a complicated one; every trade needs to be placed with the corresponding stop point. This particular rule should never be broken. You must decide prior to the trade the level of risk you are willing to accept, not during a trade when you are prone to make emotional decisions that are not based upon probability, facts, or the reality of the trade. Should the market experience an unexpected spike prior to establishing a stop loss point, your losses could amount to the entire balance of your trading account. For that reason alone, it is imperative that you have a preset stop in place when you initiate a trade. Never break this rule.
3. It's not uncommon to see a trader who is convinced he or she has come up on a great trade that is doing poorly, but the trader is convinced the trade is sound and due for a turnaround. In this situation there is a temptation to add additional contracts to his initial position. Never add contracts to a losing position. By adding contracts to a losing position you are expanding your level of risk. Again, this practice usually falls under the guise of an emotional attachment that is not based on probability or fact. Yet it is a common occurrence, and the results are usually disastrous. Just like point 1, a trader needs to accept a trade is not going to work out and adding contracts to an already losing position makes absolutely no sense. But as I have said, I see it all the time. It is my belief that some traders have a difficult time accepting a losing trade and will take extremely illogical measures in the belief they can rectify their sinking ship. I will say this one more time, never add contracts to a losing position.
While these 3 practices sound absurd as you read them, their implementation is commonplace and you must work to make sure you do not fall into a habit of taking desperate measures to salvage a losing trade. A losing trade is just that: a losing trade. By adding contracts, or moving stops, you expand your risk to a trade that may well be destined to lose money, regardless of your actions.
Questions and Answers
Learning to implement proper money management is an important skill to master to stay in the futures trading business. All too often, trader trade to many contracts for the size of their futures account balance. I give my take on sizing your future trading contract and what trading limits you should follow.
Fixed percent money management is a wonderful money management technique used by many traders with much success. As with all money management strategies, there are pros and cons, and not all money management strategies are suitable for all traders.
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