Money management overlaps with risk, trade, business and personal management, yet it has many aspects that make it distinctly different from all of these other areas of management.
Money management is usually not followed or is used only when things get real bad. Usually, it’s a bit too little too late unless you start from scratch including building up enough risk capital all over again.
Money management has some key aspects that in one way or another tends to have an influence on all aspects of trading. It also helps you to become a more consistent trader.
Listening to opinion
You should set your own trading guidelines and trade what you see. Forget about opinion, your own and especially that of others. Unless you are one of a very rare breed whose opinions are sufficiently good for trading, do not trade on them.
Make an evaluation based on the facts you have and then go with the trade. Just be sure you have a strategy for extricating yourself before losses become big. Had Kim stayed with her original strategy and stop placement, she would have ended up a happy winner instead of a regretful loser.
Taking too big a bite
Biting off more than can be chewed is a weakness of many traders. This form of over trading derives from greed and failing to have clearly defined trading objectives. Trading only to “make money” is not sufficient.
Break every trade into definitive goals. Make sure you achieve those goals before adding other positions. Even with a single short sale of the T-Bonds, Pete could have set himself a goal for the trade.
One or two full points might have been all he needed to satisfactorily retire that trade as a winner. Then he could have made his trading decision for an additional position.
There are very few traders who can successfully manage multiple positions in a variety of markets.
Being overconfident (it happens)
Overconfidence is a particular kind of trap that springs shut when people have or think they have special information or personal experience, no matter how limited. That’s why small traders get hurt trading on no more information than “hot-tips.”
We all need to broaden our horizons. We need a humble attitude relative to the markets. We can never afford to wallow in overconfidence in what we perceive as special knowledge.
A trader can never afford to let his guard down. Tim thought he knew something that others hadn’t yet caught onto. In so doing, Tim made another mistake as well. He heard only what he wanted to hear.
Hearing what you want to hear – seeing what you want to see
Ever taken a trade so convinced that you got it right only to be disappointed by Mr. Market? Well that’s nothing but preferential bias and it happens to even the best of traders
Once you develop a preference for a trade, you will very often distort additional information to support your view. This is why an otherwise conscientious trader may choose to ignore what the market is really doing.
I’ve seen traders convince themselves that a market was going up when, in fact, it was in an established downtrend. I’ve seen traders poll their friends and brokers until they obtained an opinion that agreed with their own, and then enter a trade based upon that opinion.
Look at each trade objectively.
Do not allow yourself to become married to your opinion. Learn to recognize the difference between what you see, what you feel, and what you think. Then, throw out what you think.
Lock out the input of others once you have made up your mind. Don’t let your broker tell you what you want to hear.
Never ask your broker, your friends, or your relatives for an opinion. Turn off your TV or radio, you don’t need to see or hear what they have to say about the top stocks of the day. Take all indicators off your chart and just look at the price bars. If you still see a trade there, then go for it.
There is a huge difference between being risk averse and fearing losses. You must hate to lose. In fact, you can program your brain to find ways to not lose. But not losing is a logical thought-out process, rather than an emotion-based reaction.
Two human-based tendencies come into play. The first is the sunk-cost fallacy and the second is the exaggerated-loss syndrome
Valuing invested money more than won money
Traders have a tendency to be more careless with money they’ve won than with money they’ve invested. Just because you won money on good trades doesn’t mean you should gamble with that money.
People are more willing to take chances with money they perceive as winnings as though it were found money. They forget that money is money.
Valuing money depending on where it comes from can lead to unfortunate consequences for a trader. The tendency to take greater risk with money made from trades than with money invested as capital makes no sense.
Yet traders will take risks with money won in the markets that they would never dream about with money from their savings account.
Wait awhile before placing at risk money won on trades. Keep your trading account at a constant level. Strip your winnings from your account and put them in a safe conservative place. The longer you hold on to money, the more likely you are to consider it your own.