My Thoughts on Correct Trading Money Management

I’ve written a few articles on the topic of money management and the main idea I try to convey is that it’s arbitrary for someone to trade a percentage of their account. There are many factors affecting how any one trader should manage his or her money in the market; net worth, personal trading skill and confidence, risk tolerance, etc., the point is that every trader is different and has different circumstances that dictate the best way for them to manage their money.

Due to these varying circumstances between traders, it simply makes no sense to recommend (as many ‘experts’ do) that traders risk 2% or some other percentage of their account. My approach to money management is a much more personal one as I believe each trader’s money management plan should vary depending on their individual circumstances.

Why you shouldn’t risk a fixed % of your account

Let’s assume for a moment that you have a 50% drawdown on your trading account, not unheard of even for a professional trader. If you have such a drawdown and you are risking 2% on every trade, it’s going to take you an extremely long time to build your account back to where it was. If you lose 50% of your account, you need to make a 100% gain on it just to recover that loss, and risking 2% per trade is not how a professional would recover from such a loss, because it would take virtually forever.

If you are a skilled and confident trader, why would you relegate yourself to risking only 2% on every trade you take? Perhaps if you are a day-trader who enters many positions per day this 2% approach might make sense, but as I discussed in my article on why I hate day trading, I am not a day trader and I do not teach or condone day trading.

The way that I trade and the way I teach my students to trade is to take a very patient, sniper-like approach so that we are not over-trading. Instead, we may only take a small handful of trades each month, but we feel confident about those trades and as a result, we give ourselves a chance of making a nice profit on them.

For example, if you risk 2% per trade and let’s say you take 25 trades per month, you have effectively risked 50% of your account that month (2% x 25). Alternatively, if you risked say 10% of your account on just 3 trades per month, that would only be 30%. This is a crude example perhaps, but my point is multi-faceted:

1. There simply aren’t many high-probability trading opportunities that arise on any given month in the market. If you are trading very often as in my first example above, you are over-trading and unnecessarily risking your money in the market, essentially you’re gambling.

2. If we instead trade less frequently but perhaps trade a bigger position size when we do trade, we are giving ourselves a much better opportunity to make money while reducing our stress, frustration and ‘gamblers’ mentality. This obviously assumes that you know how to trade properly and you know what your trading edge is and you are sticking to it/ waiting patiently for it to arise.

Now, before anyone jumps to conclusions from my example above, I am not necessarily condoning you risk ‘10%’ of your account per trade. My point was to show that trading less frequently but more precisely and skilled, can allow you to be confident because you know you will risk a decent position size on the trades you do take. Many people feel if they trade daily charts and swing trade them that they are ‘missing out’ on opportunities because they may not be in the market everyday like a day trader, but what I am trying to show you is that this is an erroneous way to think about trading.

The proper way to think about trading and specifically money management, is that trading less but more precise and disciplined will give you plenty of opportunity to make ‘a lot’ of money, you just have to have the patience and mental fortitude to make it all work.

You need to protect your money from yourself

One of the most important aspects of proper money management as a trader is protecting your money. More specifically, I’m talking about protecting your money from the risks of trading too frequently or gambling in the market.

It can be extremely tempting to jump back into the market after you have a winning trade. In fact, I’ve found that it seems to be almost an innate human tendency to become overly-focused on finding ‘another trading opportunity’ right after winning a trade. Your defenses go down after a win, as does your overall perception of how risky trading really is. In essence, a winning trade can lull us into a sense of complacency to a certain degree.

As a trader whose number one goal is to protect their money and get the most out of it in the market, you have to be very vigilant after a winning trade so that you don’t lose the discipline that probably brought you that winning trade in the first place.

There is no worse feeling than giving back all the profits you just made on a trade that you patiently held for multiple because you jumped in and out of the market a bunch of times the very next day. One of the best ways to protect your money is by sticking to your trading strategy no matter if you’ve just won or lost on a trade, and not letting the results of your previous trades influence your next trade.

Your trading account is a margin account

Due to the fact that a Forex trading account or similarly, a futures trading account, is highly leveraged, there is no need to keep all of you trading money in the account or calculate your risk per trade based on a percentage of that account.

To compare, take a stock trading account for example. A stock trading account is not leveraged in the same way a Forex or futures trading account is. For that reason, you do need to keep most or all of your trading money in a stock trading account, and it’s not a ‘margin account’ like Forex or futures.

Margin means you can control a much larger value of currency or commodity than what you could buy with the money you have on hand, and leverage is what allows this to happen. For example, to control say $100,000 worth of currency, or 1 standard lot, you only need about $1,000 in your trading account with 100:1 margin ratio or ‘leverage’.

So, as you can see, when trading a highly leverage instrument like Forex, we do not need to keep all our trading money in our account, so it makes no sense to calculate our risk based off our ‘account size’. Instead, I propose a much more personal and perhaps intuitive way to determine how much to risk per trade…

So, how much should I risk per trade?

I probably get this question of ‘how much to risk per trade’ or ‘how much to fund my account with’, more than any other on the email support line.

The answer is much simpler than what you might currently believe. I believe in determining a dollar amount that you are comfortable with losing on any one trade, and sticking to that dollar amount at least until you have doubled or tripled your account, at which time you can consider increasing it.

This amount should be an amount that satisfies the following requirements:

1. When risking this dollar amount, you can sleep sound at night without worrying about trades or checking on them from your phone or other device.

2. When risking this dollar amount, you are not glued to your computer screens becoming emotional at every tick for or against your position.

3. When risking this amount, you should be able to almost ‘forget’ about your trade for a day or two at a time if you have to…and NOT be surprised by the outcome when you check on your trade again. Think, ‘set and forget‘.

4.When risking this amount, you should be able to comfortably take 10 consecutive losses as a buffer, without experiencing significant emotional or financial pain. Not that you would IF you’re sticking to an effective trading strategy like my price action strategies, but it’s important you allow that much buffer for psychological reasons.

In summary, money management should not be based on some arbitrary percentage of your overall trading capital. Rather, it will and should vary from trader to trader depending on things like your net worth, trading skill and confidence and your tolerance for risk on a per-trade basis. As these things vary from person to person / trader to trader, the amount of money that you risk in the market and the amount you risk on any given trade, has to be an amount that works for your personal situation. Most importantly, and if you remember nothing else from this lesson, your risk should never exceed what you are mentally and emotionally OK with potentially losing on any given trade.

Remember to leave a comment below and please don’t hesitate to email me here with any questions or concerns you may have.