There are systems that are based upon money management alone.  The principle  is basically the 1/2 way to the wall principle.  If each time you go 1/2 way to the wall you will never get there.  I have heard so many say that they will take 10% loss or a 5% stop.  That like the 1/2 way to the wall theory is, if each time you take a 5% loss you can never be out of money.   A stop shouldn’t be based upon financial pain it should be based upon the fact that the chart says you are wrong.  I use a 2% risk factor.  That means if I had a $10,000 account I could risk $200 on each trade.  I would then look for a trade where a move of $200 would make me wrong.  So the trade is adjusted to that risk parameter.  If it requires you moving down to 60 min. chart or 15 min. chart to do that then that is where you should be trading. 

We always talk about risk. Risk is a major part of money management.  If you own a home you have it insured.  If you own a car, boat or airplane you have it insured.  In each case you don’t expect or even think about having your house burn down, an auto accident or do you expect to die if you have life insurance?  Yet, when you put on a trade you don’t think of insurance of any kind.  Here is a situation where you can lose almost everything you have in an instant and there is little or no thought of insurance of any kind.  Oh,yes.  I have a stop.  I remember the day when a friend of mine lost $80 million in a little less then 2 hours.  Someone else I know lost $20 million in the same time period. He also lost two shopping centers in Florida, and one in Los Angeles.  I was with him the day that he went in and paid cash for an Aston Martin Vantage roadster and now he was broke.  These two gentlemen were not  new traders.  They had made their money trading over a period of time and lost it all in a few hours.  How many of you have lived through 5 limit down days in a row?  Have you been around when they stopped trading the S&P and then the OEX and then everything else you could think of to short and then stop trading completely.  I saw options $60 out of the money trading for $75 and no sellers.  So when you put on a trade think of the risk and not only of  the reward.  If you control your loses the profits will take care of themselves.

There are a lot of reasons why people go broke trading and money management is a key factor.  No business plan is another reason and a total lack of knowledge is a third.  Because you were a successful lawyer, doctor, engineer or entrepreneur doesn’t mean that you will be a good trader or a good investor.  Think about how long it took you learn the profession or trade you were in and what it cost.  Because you were successful there is no reason for your success in this arena.  You have to learn how this business works and what it takes to be successful in it.

You may think that I am yelling the sky is falling, but I am just putting out some information so that you can rethink your risk strategy.

Let us take an example using the SPY.  You buy 100 shares of SPY because your chart says that it should go higher.  The cost of the trade sans commission is $9012.  Because of the standard deviation you feel that your risk should be about $2.   That falls within your 2% risk factor.   But there is still almost $9000 at risk.  What happens if there is bad news, another twin towers type incident and the markets don’t open and the next day SPY opens at $60.  Now you are down $3000 and if you are on margin you have big problems.  Instead of buying the stock for $9000 you buy the 85 August call for $6.45.  Yes,  there is time premium in the call but your total risk from zero to infinity is $645.  If SPY doesn’t do what you think it should do, you sell the call.   If it does what you think it will do you make just about what you would have if you owned the stock.  That is just one way to reduce risk.  There are literally dozens of others.  Always think about how much you can lose, it is the key to success.

Good trading, Ira