Defensive Money Management Explained: IntroductionBy on 2010 Nov 23 Tue 18:33:00
Written by Lawrence Chan. All rights reserved.
Note: Originally I intended to write this series of articles as a side project and publish the complete set in PDF format. After showing the first few chapters to my colleagues, however, it is obvious that money management is such a big topic it will take me forever to complete the series given my hectic daily schedule. The other issue is that the target audience of these articles do not necessary share the exact same interest in money management due to the differences in the instruments they trade, thus not all articles will be of interest to everyone.
I have decided to publish the first few chapters online for now, and see if I can keep up the pace to release more articles on a weekly basis. Feel free to email me with your feedback email@example.com
Index page is here.
Money management is an often ignored topic in trading because, frankly speaking, no one is interested in the topic of how to lose money properly. What everyone wants to know is how to win money quickly and if you are writing books on trading, it better be something about trading techniques that show the readers how to pick the tops and bottoms. For money management related trading books, all of them focus on the concept of optimizing the potential profit. People are just too busy seeking for that next best trading strategy. They will worry about money management issues later because many of these traders think that they do not have a lot of money to start with anyway so being conservative could reduce their chances to succeed in trading.
It does not sound right when we put conservative thinking like defensive money management together with speculative activities like trading and daytrading in the same sentence, does it?
Why would anyone engage in speculative activities like trading would think conservatively at all?
Well, those who successfully make a living through trading everyday (or those who successfully grow their capital with part-time trading) and end their trading career at their terms (i.e. choose to retire and stop engaging in financial speculations) would tell you otherwise. I call these individuals achieving practical success in trading (in my eBook Know your odds before you trade). Being defensive in the money management aspect of trading is one of the most important factors that drive the success in many retail traders’ trading careers.
But what is defensive money management anyway?
How do you tell the difference between financial speculation and gambling your money away?
The intention of this book is to show you that you can find the proper answers yourself given your specific financial situation, trading experience, etc.
Principles of Defensive Money Management
In trading, money management in general deal with the amount of money you are willing to risk in order to gain the opportunity to profit from the speculative act. To be defensive in money management, it means that,
- you have to understand the risk assumed in your trading activities very clearly
- you have well controlled risk per trade relative to available trading capital
- you have exact rules in position sizing that help growing the capital base without taking on risk that is not manageable
- you will stop all high risk trading that is not suitable for your trading account
The above principles are pretty descriptive by themselves. I will not go into details explaining them within this section because each principle should be explained clearly with examples to avoid any misunderstanding.
Since my intention is to make this a practical guidebook, I will continue the rest of the book with minimal amount of mathematical formulas. Whenever possible, visualization of the above principles will be provided to make it easier to understand certain concepts. (Trust me, avoiding the use of math formulas is the biggest challenge of all in delivering explanation of money management concepts.)
- end of part 1 -