Hopefully you will have read about my own experience of ignoring my own Money Management rules. It was a very hard lesson, and hopefully you will heed my advice and ensure that you religiously stick to your own Money Management rules.... It really can be the difference between growing your capital, and losing it altogether!
In case you have yet to define your own Money Management rules, I thought I would write some things for you to think about. I hope you are able to take something from these to improve your Money Management and Trading.
To my mind, and from my reading, you need 4 key things for your money management rules, these being:-
1. A Defined Stop Loss
Before you enter the trade, it is crucial for you to know where you are going to place your stop loss. This is the price where, if the market goes against you, you no longer want to be in the trade.
Typically, there are two main types of stop used by retail traders.
a) Equity Stop
This is the simplest of all stops to calculate. Basically, either through the rules of your Trading Strategy, or indeed your trading style, you have a predetermined number of pips you want to place the stop at. There are some that do not like this type of stop in that it bears no relationship to the price action of the Market. That said, if it is Trading Strategy related, and that strategy is netting you good pips each month, then the success rate of the Strategy itself is justification enough to use it.
b) Chart Stop
This stop is based on technical analysis, so essentially driven by price action. As a Trader you will have various important levels and trend lines on your chart. These may be Pivot Points, Fibonnacci Levels, or defined Trend lines with 3 or 4 'touch points', but whatever they are, you are essentially making a projection that, should your trade go against you, there is a good probability that the technical level you identified will hold the market and reverse it back in your favour. The downside in this type of stop of course, is that your technical analysis will probably identify lots of potential stop levels! You must however be disciplined, and identify just the one most probable, and stick to it! Now, you don't want to be putting your stop loss directly on that point, so you could place it maybe 5 or so pips past the actual level (some call that 'wiggle' room!).
2. A Per Trade Risk On Your Capital
This is the amount of money you will risk on any one trade, defined as a percentage of your capital. There are various guidelines to this, and most would be dependant on your experience and success as a trader, but they range from 1% to 5%. Personally, when starting out, I risked no more than 2% of my capital, but mostly use 3% these days.
3. A Maximum Daily Loss
You need to set yourself a maximum amount of your Capital, defined in percentage terms, you are willing to risk in any one day. I personally found this very, very useful, but also very, very hard to adhere to. Again, various opinions are written on this subject, but 6% to 8% is typical, so you are essentially limiting yourself to 2 or 3 consecutive losses if you had no winning trades that day.
4. A Discipline to Take Profits!
For me, this is as important as managing the losses on your Capital. Always define a Take Profit target before you enter a trade. Like Stop Losses, Retail traders generally use two types of Profit take targets, and they are exactly the same as Stop Loss.
a) Capital Take Profit
As with the Stop definition, you have a predetermined number of pips Take Profit target, either through the rules of your trading strategy, your trading style, or your risk/reward ratio - another topic!
b) Chart Take Profit
Again, as with the Stop definition, your Take Profit target is based on technical analysis, and therefore Fibonnacci, Pivot, Trend lines, or maybe Daily/Weekly Highs/Lows will determine that. As with the Stop definition, don't expect the market to stop directly on the line, so possibly place your target 5 or so pips before the price (not after as in your stop). Also, be disciplined enough to identify the most probable Take Profit Level, and don't change it based on other levels that might come into play! For example, you may reach your Take Profit target very quickly, so you decide to let the trade remain, expecting it to reach another level you have on the chart... You may be totally right, and the trade will go further in your favour, but... what if it doesn't? You may have thrown away already earned profits, particularly if it retraces back as quickly as it got to your first Take Profit point!
There are other options you can use to take advantage of any further potential moves that may go in your favour... One such option would be to take part of your profit, move your Stop Loss to Break Even, and let the rest of the position ride to the next exit strategy. You have at least locked in some profit. Be careful this strategy does not mess with your Risk/Reward ratio....
For me, employing Money Management rules, and being disciplined in their use, made a big difference to my trading. If you are not yet trading with any Money Management rules, you should start defining and employing them as soon as possible - possibly before your next trade! If however you have yet to start trading, make sure to take time to define your Money Management rules before you put on your first trade..... You'll be glad you did!