Life becomes striking and cheerful when you invest right and trade right. Money Management is to be dealt very cautiously. As it is important for survival and valuable for life and progress. Money holds unique relationship with each person independently. Certainly, it has an individual perspective and an own unique way of both spending and saving money.
Money management, it is all about expense tracking, investing, budgeting, banking and evaluating taxes of one's money which is also called investment management. It is a strategic technique to make money give the highest interest-output value for any amount exhausted. Spending money to satisfy cravings is a normal human phenomenon. The idea of money management techniques has been developed to reduce the amount that individuals, firms, and institutions spend on items that add no significant value to their living standards, long-term portfolios, and assets.
Trading, it is a process of buying, selling, or exchanging commodities, at either wholesale or retail, within a country or between countries. Trading is of course a numbers game and money management is the most important component of a trading plan. It will determine how much you make (earn), and applying the right one (invest) will make the difference between single-digit returns and making the kind of money you deserve or worthy.
Based on above two insights we draw a conclusion regarding the money management about how both are interlinked and dependent on each other. Consequently, we can now focus on how these two basic approaches towards money management. There are 2 basic approaches to money management, martingale, and anti-martingale. Martingale increase the position size with losses. As the account is in a losing streak the trader will double the position size in order to re-coop all the losses and make a little profit. Anti-martingale process is the opposite. The position size increases with wins and decreases with losses.
Money management strategies for effective trading are as enlisted below;
1. The 2 Percent Rule Method
This is an investing strategies where an investor risks no more than 2% of their available wealth on any particular/ solo trade. The 2% Rule is an anti-martingale money management method that is based on your account volume. It can be calculated based on the formula as mentioned below;
Risk per Trade = Account Balance X 2%
To apply the 2 percent rule, you can use a position size calculator that is very easy to use that will spit out your position size for each trade with just a few clicks. Brokerage fees for buying and selling shares should be factored into the calculation in order to determine the maximum permissible amount of capital to risk. The maximum permissible risk is then divided by the stop-loss amount to determine the number of shares that can be purchased. This rule is a restriction that investors impose on their trading activities in order to stay within specified risk management parameters.
This is a conventional approach that focuses on limiting risk and is an ideal method if you are a new trader just starting out. It will keep you in the track while you build your confidence and valuable experience in the trading format. Big accounts don’t need to risk as much to achieve acceptable returns.
On the other hand, It is not really growth-orientated and difficult to use in some leveraged markets. Traders starting with smaller accounts are willing to accept more risk in order to make more money.
2. Fixed Fractional Method
The basic understanding in simple terms is that fixed fractional trading assumes that you want to limit each trade to a set portion of your total account, often between 2 and 10 percent.
One fixed fractional method commonly used is to trade 1 contract for each X amount of dollars in the account. X can be set to be a large or small number.
X = $10,000; If Account Balance = $20,000, then Position Size = 2 contract
To apply this method you would begin trading 1 contract, and once your account reached $30,000, then you increase your position size to 2 contracts, and so on.
When X is too large then this method is risk-averse but growth is slow. When X is too small then growth is quick but there is a possibility of shattering loss.
3. Optimal f Method
Money management strategy, Optimal f is used to improve and maximize system performance by finding the best percent of capital to invest in a specific trade. This strategy determines which percent of equity invested in a trade would have yielded the highest return based on a sequence of past trades.
Since traders are able to employ a variety of money management strategies, it can be useful to know what would have been the optimal amount to invest in each case.
This method was developed by Ralph Vince, and it is a mathematical model to determine 'f' stands for fraction. The method solves for the optimum fraction from a given set of trades that will produce more returns than any other fraction. This method has great growth potential but susceptible to ruinous risks. If you are fascinated and are mathematically inclined, we highly recommend reading all of his books.
4. Secure f Method
Secure f is a safer adaptation of Optimal f. To devise the problem solved by secure f, we add a constraint into the calculation of optimal f. The constraint may reflect the acceptable maximum drawdown (and/or other characteristics). This is a more conservative strategy that has the benefit of finding the percent of equity invested in every trade that would have yielded the highest possible return subject to the acceptable maximum drawdown. The risks have become manageable but at the expense of geometric growth.
Taken as a whole, the theory behind Optimal f and Secure f makes a lot of sense, but we aren’t sure of the practical application, except maybe for the World Trading Competition where Larry Williams became the all-time winner turning $10k into $1.1 million in just 1 year.
5. Fixed Ratio Method
The fixed ratio money management method was developed by Ryan Jones and presented in “The Trading Game”. It is a extremely different approach to money management. Like other money management approaches, it increases your lot size as your account grows, thereby compounding your trading returns. In the fixed fractional approach, you risk a fixed percent of account equity per trade. Lot sizes are computed using the number of pips risked per trade.
Fixed Ratio focuses on profits made rather than the size of the account. There is just one variable called the “Delta”.
Delta = $1,000; Position size increases when $1,000 per contract in profits are made.
The delta is determined by the max drawdown of your trading plan. If your strategy produces large drawdown, he recommends a delta of 1/2 the max drawdown and equal to or greater than the max drawdown for low drawdown strategies.
The profit you need to accumulate, per lot increment, before you can increase your lot size by one increment. The delta determines the aggressiveness of your money management. The smaller the delta, the faster your lot sizes increase, and the more risk you assume.
As long as you have enough capital in your account to cover risk, margin, and some breathing room, it doesn’t matter whether you have $10,000 in your account or $100,000, the size of your account is not a factor.
Begin trading with 1 contract and once you’ve made $1,000 in profits, increase the position size to 2 contracts. Since you increase the position size with every $1,000 made PER contract, increase the position to 3 contracts once you’ve made $2,000 in profits.
This method is appropriate for smaller accounts. The risk on the account peaks at the 4-5 contract level and continually decreases as the account grows. It isn’t optimum for larger accounts of over $1 million, but it is a method that will get you there most efficiently.
Money management is more common sense than rocket science. Planning, preparation and checking calculations are must to exercise before any investment. This piece of information will be effective for an cautious trading to improve growth and efficacy in trading for the future growth prospectus.