Money Management: The Real Holy Grail

Money Management: The Real Holy Grail

Fellow Traders:

A key component to successful trading is proper money management.

Traders, in general, spend far too much time and effort trying to find magical systems or methodologies that produce high returns, rather than increasing their understanding of the markets and using astute money management to apply what they learn.

I agree with Stanley Kroll who once said:

"It is better to have a mediocre system and good money management than an excellent system and poor money management."

In this first week of our 10-week course, I'm going to teach you everything I've learned about the discipline of money management in the past 17 years of trading and fund management. You'll not only review some familiar rules, but also learn about some powerful principles that go way beyond just cutting your losses short and letting your profits run. Even though these principles can make you a lot of money, I doubt that you'll hear very many fund managers or system vendors talking about them in their ads because they know that the public is drawn toward glitzy performance numbers--not risk control.

But, if you want to know the real truth about what it takes to be a successful trader, be assured that I won’t pull any punches.

Now let's get started. The first three rules are what I consider to be the most important. Without them, everything falls apart. I consider them to be the very foundation my success as a trader.

The first one is:

Rule 1: Minimize Losses!

As simple as it sounds, failure to keep losses small is the #1 reason why most traders blow out early in the game. That almost happened to me, in fact.

When I first started trading, I bought call options on gold stocks right before the big explosion in Gold prices in 1979. In less than a year I made 500% on my money. I thought I knew everything. But then my real education started.

In 1981, I got caught short Orange Juice during a series of limit-up moves that lasted more than a week. By the time I exited, I had lost nearly half of my account. It was at this point that I realized the importance of limiting my losses.

Very few traders understand the mathematics of losses and risk. But I believe that just understanding the following concept can turn a losing trader into a winning one because it can help you to focus on doing the right things and turn you away from the wrong things.

Here is the concept that I strongly suggest you chew on for awhile:

• When you lose money in trading, you wind up having less capital to work with. Therefore, to make back what you lost you have to earn a substantially higher percentage return than what you lost.

Example: If you make a series of bad trades and your account drops 70% in value, you will not get back to your break-even point until you have made over 230% on your remaining money!

That doesn't sound fair does it? You'd think that if your account dropped 70%, you'd be at the break-even point again when you've made 70%. Sorry, but this is not reality. A trader who loses 20% or more must show a return of 30% to make up for the loss. It can take a year or more for even the best traders I know to produce such a return.

This is one of the principles that keeps many losing traders from digging themselves out of the hole they've dug for themselves. They lose a big chunk of money and, even if their skill improves, they are not able to recover unless they add more money to their trading account--usually from their hard-earned paychecks or credit cards.

As I studied the qualities of successful traders, the concept of weighing risk and reward hit home. Trading performance meant more to me than just shooting for big gains; it meant looking closely at the risks I was willing to take to make those gains.

Indeed, as I studied the qualities that the most successful traders have in common, I noticed that most strived to keep their draw-downs to around 20% to 30% or less.

When you trade, you always have to be conscious of the dangers of suffering big losses. You not only lose the money, but you also have the potential to be knocked out of the game permanently. Realizing this will produce a fear in you that I assure you will be quite healthy. That fear will help you to remember to keep your position sizes small and to apply trailing stops religiously.

Winning traders minimize losses.