The most important aspect of trading is money management.
So just what is money management? It is the practice of balancing risks with rewards in an attempt to maximize returns. More specifically, with sound money management techniques, we can calculate our risks and expected returns, calculate the size of our positions, limit our potential losses, and maximize our profits. Of these, cutting losses is probably the most important. Take care of the losses and the profits will come.
Anyone who has read the Market Wizards books will know that there are at least three components to successful trading:
1. The trader's psychological makeup.
2. The trading systems edge.
3. And, strict money management.
In a study by Fernando Diz, an assistant professor of finance at Syracuse University School of Management, he found that most successful trend follower traders were very similar in their trading edge via their trading systems. The difference between them was in their losses.
The traders with the highest average returns have consistently smaller losses.
To be successful as a trader, one must learn to lose small.
Mr. Diz found that on average, most trading programs took at least 20 months to recover from their worst drawdown without increasing the amount of risk.
By not learning to lose small, it explains why less than 5% of retail investors beat the market on a consistent basis and only 20% of professional traders do.
Mr. Diz says, the most important aspect of trading is money management. Avoid large drawdowns and recover from them quickly without increasing risk.
Avoiding large drawdowns is one of our objectives here. You will note that stop losses are set to take minimal losses.
The most important aspect of trading is money management. |
