- money management -
Now that you have an accurate trader profile, initial capital, portfolio and entry rules, you can start trading.
- Money management strategy -
The next step is developing a good money management strategy, this is crucial for more profitable trading. When you start trading, you can't just start buying and selling securities with random position sizes or without an exact risk/reward in mind. Money management helps you control the risk you are willing to take and improves your capital lifespan.
position size
The size of your position determines the number of contracts of a security you buy. There are several ways to size your positions, best taking into account your risk aversion. If you don't want to lose x percent of your capital, you need to size your position accordingly.
You can size an investment based on the percentage of capital you are willing to risk, or size based on whether the market is volatile or not, using a lower position when the market is volatile to to reduce the risk.
Stop losses help protect you from swings that are opposite to what you expect. Trading without a stop loss exposes you to potentially volatile swings that will significantly affect your capital.
Generally, stop losses are set at a certain price level, once the price hits that level your current position will be closed. Some platforms also allow you to set the distance between the price and your stop loss based on a value in pips, dollars or a percentage.
ATTENTION! A stop loss will be filled as soon as it is triggered, but that doesn't necessarily mean it will be filled at the set price! Therefore, you could have additional losses that you did not expect.
Your initial capital and risk aversion are the most important factors when it comes to placing a stop loss. If you can't afford a $100 loss, place your stop loss accordingly, but there are more factors to consider as well.
Volatility is an important factor, if a trader expects volatile moves, a stop loss too close to the price may trigger too quickly, creating an unnecessary loss. Place your stop loss with price fluctuation volatility in mind. If you are willing to trade a more volatile move, you are willing to take more risk as it will give your stop loss some wiggle room.
The trading horizon and profit target are also an important factor, long-term trades with a more significant profit target require a stop loss further away.