7 Dangers of Not Having a Money Management Plan When Trading
Education - AxiTrader Team | 10 Oct 2019
Have you ever watched the World Series of Poker championships where the best poker minds in the world battle it out to be crowned grand champion?
One thing you will notice while watching is the percentage chance of each hand. You may even find you yell at the screen going ‘Why would you bet aggressively on that hand instead of folding? You only have a 12% chance of winning,’ as you throw down your popcorn and walk away in disgust.
If you were ever able to watch professional traders in action, you would notice a similar trait in that the best players systematically know their odds.
They are so aware of when their trading ‘edge’ is present and when conditions are ripe for high-probability trading set up versus a ‘C-trade set up’.
Your job, as a soon-to-be professional trader, is to build a clear edge within your trading systems and apply it when your edge is present.
When your edge is not present, you should not trade.
But winning a World Series of Poker championship isn’t just about knowing the odds. Let’s face it; you have to outlay $US10,000 to enter and then beat more than 7,800 poker players to be crowned champion.
The most important skill is knowing how much to place on each hand and to press when the odds are in your favour.
And so too with professional traders, you need to build into your systems a strategic money management plan that allows you to cut your position when it isn’t working and maximise your opportunities when you are winning.
The old maxim rings loud and true when it comes to trading in that you must ‘Cut your losses and let your profits run.’
In today’s post, we are going to run through the 7 dangers of not having a money management plan and what it will mean to your bottom-line results.
1. Losing all your hard-earned trading capital
The truth is, when it comes to Forex trading, you can lose more than what you start with. Once your losses get too big, you are out of the game. Capital preservation is critical for you to stay in the game.
2. Being clueless with how much you need to risk on each position you take
You must know how much is appropriate to risk based on your account size and the volatility of the instruments you are trading. You cannot just trade the same dollar amount or random dollar amounts and expect a smooth, rising equity curve.
3. Believing that one trade will ‘finally set you free.’
We hear this time and time again. ‘All I need is one amazing trade, and I can finally say goodbye to my dead-end job’. This is not how trading works. You must steer clear of this mindset and instead build up your consistency and learn how to apply your edge across the markets in a consistent, steady fashion.
4. Averaging down into losing trades
This will always be the eventual death of a trading account. It might not happen this year or next year. But if you average down enough and do it aggressively, you will wipe out. Do not average down. Averaging down is also referred to as a martingale position sizing strategy where you increase the size of your position as you are losing. This is the opposite of professional trading. Professional traders employ anti-martingale position sizing strategies.
5. Not knowing how to add to winning trades
The guiding principle of trading is to cut your losses off short and let your profits run. In addition to letting your profits run, you must explore the option of adding to winning positions. This is dependent on the type of system you have with trend following systems being able to take advantage of this principle the most.
6. Revenge trading is part of your toolkit
Emotionally driven trades are a huge danger zone if you want a healthy trading account. Do everything you can to eliminate any form of revenge trading. Treat each trade as independent of the previous one with a new expectancy and the ability to focus on quality execution of your trading plan.
7. Knowing when to cut back when you are on a losing streak
Another big danger zone for traders is combining revenge trading with a losing streak. The amateur trader will get their blood pumping and think in terms of ‘How big does my next position need to be to win back all my previous losses and then some?’. Instead, a professional trader will stop trading or halve their position size until the numbers of their system match their backtesting results.
We’ve run through 7 dangers of those who don’t have an effective money management plan in place. Of course, there are more, but the underlying foundation of all sensible money management plans focus on capital preservation. Trade well and trade small.
To learn more about system position sizing, how to achieve your system’s objectives and how to make meaningful changes to your system, download our exclusive eBook on ‘3 Ways To Achieve Your Objectives With Positions Sizing And System Monitoring’.
The information is not to be construed as a recommendation; or an offer to buy or sell; or the solicitation of an offer to buy or sell any security, financial product, or instrument; or to participate in any trading strategy. Readers should seek their own advice. Reproduction or redistribution of this information is not permitted.
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