18: What Money Management Is and is NOT
Highlights and Takeaways:
- Money Management can make you or Break you!
- Money Management is not just for large accounts. It is for all acounts.
- If you place a trade on any instrument and timeframe, you need a money management method.
- Learn about Proper vs Improper Money Management
Let’s talk money management (MM) now. For the next couple episodes after this one we are going to be exploring a couple different MM systems out there. Not going through every one in the world, just the top management systems out there.
Now some people have different definitions of money management. My definition of money management is this:
Money management is how much of your accounts equity will be at risk on the very next trade. And every other trade for that matter.
It is 90% of the game
Money management is one of the most important aspects of trading, period. It is quite literally 90% of the game. When it comes down to the bottom line, nothing beats money management.
Don’t think so? Lets take a 5-year return for example. Money management can take an average or even less than average return and produce more than enough profits to be able to retire during the same amount of time.
It is that important. For instance, let’s say that a trader has made $50k this year, and then next year looses that $50k without using proper money management. Had they used good money management that $50k could have grown to $300k instead and then when the large drawdown came, as much as $100k could have been protected.
So the trader not using money management would be at $0 and have nothing left, the trader that used proper money management would have at least $100k left.
Larry Williams, a great trader, turned $100k into $1.1 million in a single year with proper money management. And said that it was hands down the biggest part of his success.
I have learned that Money Management is fascinating
You know, when I first started in trading, I read a book called “Trading For a Living by Alexander Elder“. And in the book it talked about having good money management. So I knew it was important. To me, it became fascinating. I was always a numbers person anyways. My mom made sure of it.
She was a CPA and owned a hospital and multiple medical centers around Florida. And because she was a numbers junkie, she turned me into one as well.
But money management is not just about numbers. And that is why I found it so intriguing and interesting. Some traders will say that if you look up boring in the dictionary, you will find the definition to be money management. But I don’t find that to be the case.
Now when I first started out, I didn’t use the same money management system I use now, But I still knew that money management was important and had to learn about it and use it from the very beginning.
MM can and should be used on every instrument and timeframe (longterm, short term) it doesn’t matter. Anytime you place a trade in any market, money management should be applied. and not just any money management that comes out of your head. Proper money management. We’ll get into that in a second.
And since I started learning about money management, I have read over 30 books on money management and consumed every single video and course I can find on the subject. So you can tell that I don’t find it boring.
%% “No matter what market or method you use or trade in, every single trader must make a money management decision prior to entering a trade”
Isn’t money management just for large accounts?
And money management isn’t just for large accounts either. It doesn’t matter if your account size is $5000 (which I feel is minimum for a trading account), or $5 million.
I read on a forum someone talking about how they didn’t see a point of using money management because their account was very small and there was little to no point in using it.
What they fail to see is that with proper money management, they could quickly turn their micro account into a decent size account with minimal effort. I even tried talking with this person one-on-one. But to no avail. They just wouldn’t have it.
But take it from me, no matter what size account you have, you need to utilize proper money management techniques.
Proper and Improper MM
Money management can be broken down into two categories. Proper and improper money management.
- Proper money management takes into account both risk and reward factors. It takes into consideration the value of the entire account. Proper MM also discounts all factors that cannot be mathematically proven.
- Improper takes only one into account. Either risk or reward. But not both. It also only looks at certain account properties or characteristics such as winning percentages or win/loss ratios. Improper MM suggests that you can consider factors which can not be mathematically proven.
Now money management never dictates where to get in or out of the market. That is something totally separate. We are just talking about how much we are risking on each trade. Thats it. And money management “stops” are different as well. That is just telling us where to cut our losses and is classified under Risk management and not money management. And although they are really two sides of the same coin, they are very very different.
Types of Money Management Systems we will be covering
- Fixed Fractional
- Optimal F
- Secure F
- Martingale Systems
- Fixed Ratio
- Smoothed ratio / Slowed Ratio
When should a trader learn about and apply money management?
That is a great question. I have had arguments with people over when you should start applying proper money management. There is even a popular trader out there that teaches trading that says that when a person just starting out starts to demo trade, they should care less about money management. Just trade. And although I have respect for this person and they are a really good teacher, I have to disagree with that.
We have fought on the subject many many times and even caused this person to go on a rant on Youtube and in their own live trading room on the subject. And to be honest, they made absolutely no logical sense on why you should not use proper money management.
All they kept saying and boiling down to was that when you first start out demo trading, that you should focus solely on your trading strategy of where to get in and out of the market and leave money management alone.
So I responded with something like ”So in demo trading you are telling people that it is ok for them to risk half of the demo accounts money on a single trade” And they responded with something like “no of course not. They should only use a small percentage of the money for each trade. Like 2%.
I’ll let that sink in for a second.
They just contradicted themselves. On one hand they said forget about money management, then when I brought up a question like that, they said to use a certain percentage of the accounts equity for each trade. Hate to tell you boss, but that is a type of money management. We had this argument so bad at one time that I was literally kicked out of the live trading room and my comments on the YouTube video removed.
In the very first trade you place, wether that be in a live trading account or a demo account, you should start off by using good money management. Right from the start. Anyone that is telling you not to use it, in my opinion, is a fool on the subject. As we have already gone over, you can see how important money management really is.
Links and Resources Mentioned in this Episode:
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