“The key to long term survivability and prosperity has a lot to do with the money management techniques incorporated into the technical system.” — Ed Seykota
Managing your trades is one thing.
But managing your trading account is another.
Let me explain…
Money management is the most significant factor in how your results will be steered in the long run.
So it’s how you adapt your money management rules depending on the obstacle you face.
There are many ways to go about this, but it usually boils down to these three.
Maximum risk per trade
Early in the year, I took a significant drawdown on my forex trading portfolio.
At this point, I was in a -13% drawdown, risking 1% per trade.
But I came to a realization…
If I had risked 2% per trade instead, I would’ve possibly faced a 26% loss!
Can you see how a simple increase of 1% risk per trade could’ve made the difference?
Of course, some traders could stomach it, but nonetheless…
Keeping my risk small at a maximum of 1% risk per trade helped me recover most of the losses.
Of course, your risk per trade depends on the frequency of your trades and the size of your portfolio.
But as a rule of thumb…
Risk 1% per trade when you start trading, decrease it to 0.5% when you’re doing poorly, and consider increasing it up to 3% if you’re doing well.
Maximum open trades
You’re not going to believe how many times I get asked this.
But that’s a good thing!
Because you can’t just have a maximum open trades of 20 while you are scalping the markets.
You’d probably need six eyes and ten monitors for it!
Nonetheless, the main concept here is that:
- The lower the frequency (higher timeframe) of your trades are, the more diversified you should be
- The higher the frequency (lower timeframe) of your trades are, the more concentrated you should be on a specific market
What do I mean?
It means that if you are an intraday trader who frequently opens and closes trades…
Then having a maximum open trade of 3-5 would be better.
On the other hand, if you are a trend follower with trades that can last from months to years…
Then having a maximum open trade of 20 or more diversified in different markets would be great.
Again, there’s no fixed number on what your maximum open trades should be.
That’s why I’m sharing with you the principle behind the concept so that you can decide what you think is best for you!
Maximum portfolio drawdown
When I was still in my early stages as a trader, there came a time where my losses were uncontrollable.
Even though I knew how to apply risk management, I kept switching strategies and slowly bleeding money.
It wasn’t until I lost 50% of the whole portfolio that I decided to take a step back and see what was going on.
So, starting from a $1,000.
Down to $500 in just a few months.
That would’ve set me back even more!
Now, why am I sharing this with you?
It’s because that we’ll come to a point where our actions will be dictated by our emotions that will cause us to take in more risk and gamble.
When that happens…
It would help if you had a worst-case scenario plan to STOP trading when your portfolio declines 30% to 40%.
It means that if you have a $5,000 account and it went down to $3,000 (40% drawdown) through consistent losses…
Then you must stop trading and take a bird’s eye view on things that you must improve.