General / Money Management
During one of the sessions I was teaching, a student asked me if it was wise to plow profits from trading back into the market for faster returns and bigger earnings.
That's a great question. The truth is, money management is an oft-neglected part of our trading. All the knowledge about the markets could become negligible with poor money management skills.
It’s important to remember that our capital becomes the foundation of our trading. We have to remember that this foundation becomes strong only when we realize our gains by covering our positions.
For example, if you have a USD100,000 account to trade the US market and you realize gains that bring your account up to USD120,000, your foundation has grown by 20%. Simple enough. On your following trades, you still use the original USD100,000 to be consistent and have lesser risks. If you lose 20% of USD100,000, your capital remains intact by adding back your previous 20,000 return. Your foundation remains the same and stable.
On the other hand, if you are an aggressive trader and use the whole USD120,000 to trade and lose 20%, then your foundation weakens to USD96,000. That only means that because of your aggressiveness, your original capital is currently 4% less. Now you have a bit of a problem here because you have just hit negative territory.
The idea is to build a bigger foundation without risking the collapse of your capital. The challenge is to build a bigger base through small exposures with a good consistency of profits. I think it’s wrong to build a bigger base by risking large exposures in the market by plowing back your profits.
Having said all of that, you will see that the start is a difficult, if not the hardest, part of your trading career. The start is when you expose all your capital to all sorts of risks without the benefit of a cushion that profits can provide.
As soon as earnings flow in, I believe you will be more comfortable trading with the knowledge that your foundation is already strong.
I have always advised aggressive traders that the only good time to increase your capital is when you are ready to have a bigger account base. But it is important to remember that any addition to your capital base means you are effectively “restarting” your trading career. Your capital has changed, so the rules of the game might change. You are like a grizzled prizefighter ready for a brand new round of punishment from your equally determined opponent. This opponent will want nothing more than to knock you out cold. So my advice is be ready for a good fight, again.
In trading, be ready to get into a hole at some point of your trading career. But do not make a bigger hole if you are already in it or you may not be able to come out of it alive!
I hope my students learned something important that day.
|
