All profitable trader follows a
strong money management rule. Nowadays most of the traders think that money
management means Risk to reward ratio only. But money management actually
having a lot of components including Risk to reward ratio. If a trader does not
follow a strong money management rule, he cannot grow his money in a
significant way. Money management have the following components.
1. Capital allocation for
different type of trading (intraday, swing and investment)
2. Account size or Total
capital.
3. Risk per trade.
4. Position sizing.
5. Increasing the position
sizing.
6. Incremental buying or
selling (Pyramiding)
7. Leverage for the
Trading system.
If you understand the above
seven money management rules, and if you can implement it correctly, I think
you will become profitable sooner or later and which will make you wealthy
eventually.
1. Capital allocation for
different type of trading (intraday, swing and investment): Many traders think that he can be
a specific type of money maker like, intraday, swing or Investor. But I
believe, if you really want to become a wealthy person, you need to master all
the three segments. During initial days most of the traders go with Intraday
trading only due to leverage or less capital they are having. But always
remember that you should have a correct balance and understanding of all three
types. You should allocate your capital accordingly. During initial days you
can use 40% of your capital for Intraday, 40% for swing trading and 20% for
long term investment. Once you become experience and you are gaining from
trading and if your account has grown big enough, then you can use only 10% of
your capital in intraday, 30% for swing trading and 60% for long-term
investment.
2. Account size or Total
capital.: Always remember
account size always matter in case of gaining Hugh capital. Initially use very
less amount of money for few years, just to understand the market and your
emotion and get adequate knowledge. Once you understand the market, then you
can increase your capital. But always follow point no 1 for capital allocation
as per your trading size. Remember that You need a large capital to gain a significant
amount from trading or investing. If you do not have a large capital, you might
be a profitable trader but the profits will be so small that it can affect your
psychology (make you greedy to violate your own rule) and eventually will make
you a bad trader. Understand your psychology and accordingly increase your
capital.
4. Position sizing: Position sizing or share per trade should
depend on the risk per trade only. Before executing any trade, define total
risk of the trade, that will depend on account size also. Calculate the same
and divide it with your stop loss amount, you will get total number of stocks
to buy or sell. Follow this strictly. No matter how lucrative the trade it, you
should not increase your Position without calculating your total risk and stop
loss.
5. Increasing the position
sizing: Many traders
started compounding position size after a few profits, but remember, you can
only increase your position after the initial amount is doubled, Otherwise
Total risk of your trading business will be also compounded, that can lead you
to wipe out all your capital.
For example, suppose you have
your initial capital of 5 lacs and you started trading with that, dividing the
capital in 10 parts, 50K each. And you have calculated your risk per trade will
be 5K. Now no matter how the lucrative the trade is, you should not put your
money not more than 50K and do not take a risk of not more than 5K. Suppose
after 10 successful trade your capital has become 7.5Lac. My advice is do not
increase your position as 75K each and risk as 7.5K per trade, rather you can
keep your free 2.5 Lac capital intact for any future opportunity. Or keep it as
a profit of your business. Now once you reach to 10Lac, after few more trade
now you can consider your initial capital as 7.5Lac and keep 2.5Lac free cash
with you. That can help you to maintain your psychology and help you to take
correct decision.
6. Incremental buying or
selling (Pyramiding): Many
traders, follow the rule incremental buying and selling. As per me, you should
not buy incrementally, because if the stocks take a little pull back it can
break your psychology and make you to take wrong decision. My advice would be
Buy the stocks at a lot as per your risk and sell it incrementally. For example,
if you bought a stock at 100 Rs. and the stocks has rallied to 110. you can
offload 50% of the stocks and put your stop loss up to your buying price. No
matter what happens in the market you are not going to lose. If the stocks start
rallying again, you can get more profit on the 50% of your position. This type
of money management strategy will always make you a winner.
7. Leverage for the
Trading system: This
rule applies for intraday or option traders only. Leverage can be treated as a best friend
or your worse enemy. If you know how to do trade, risk management with a winning
strategy, it will make you Reacher, otherwise you can lose everything you have.
As per me, first define how much leverage you want to take, whatever is your leverage
amount, fix it. and then do the same trade as per your risk.
For example, if you have 50K
per trade, and you are taking 5 times as your leverage amount. then for all
your trade take 2.5 Lac is your per trade amount and do not lose not more than
5K as per rule number 5. Now, for all the trades take a position of not more
than 2.5Lac amount. If you are getting a 10 times leverage, then also you
should take only 2.5 Lac position only. To balance your profit and loss amount
in long run. So, trade wisely with the leverage.
In my opinion, if you strictly
follow the above rule, you will become profitable eventually. I hope you have
understood all the points, if not comment below. I would like to explain you in
more detail way.
Follow the money management
rule and be profitable.
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