When folks start trading, they often focus on strong trade setups and potential profits.
Yet “trading” is just one part of a bigger equation. Effective money management is vital if you’re going to prosper in the long term.
In fact, as I recently discussed on my Trading with LarryLive podcast, money management is the most crucial aspect of trading.
Money management encompasses more than just risk management and how you manage your trades.
So today I want to delve into why it’s critical to your success…
How Correlations Impact Your Trades
Money management encompasses many parts of successful trading.
You’ve got to be able to take a loss on the chin and move on to your next trade.
You’ve got to be able to take wins without letting greed overcome your better sense.
You’ve got to position size properly – including sizing your trades up or down depending on how much profit buffer you have.
You’ve got to decide on your risk management plan… whether that’s tied to position sizes or tools like stop losses.
You’ve got to understand correlations – and be on the lookout if your trades are becoming too correlated.
For that last point, consider the tech stocks that have driven much of the rally…
If you bought Nvidia (NVDA) or Palantir (PLTR), you may have set stop losses to protect your gains. As such, you might have raised your stop losses as both stocks continued to rally. This can be an example of good risk management.
But good money management looks beyond the individual trades… It reviews how these trades correlate to each other.
Say you’re prepared to risk 5% on any trade. But then your whole portfolio ends up stacked in the tech sector.
Even if you’re only risking 5% of your account on NVDA and PLTR each (plus any other tech stocks you own), your portfolio could take a massive hit if the tech sector falls over. That’s true even if you stick to your individual stop losses.
This can be tricky sometimes, as correlations can change…
At the beginning of my career in the 1980s, bonds and stocks used to move inversely to each other. You would often be long one and short the other.
Then they started moving in tandem. Anyone following the old inverse correlation suffered serious losses.
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Building Your Trading Profits
Money management also involves managing your profit and loss (P&L) tally.
It begins with the size of your trades… It’s vital to start small and steadily build your trading account.
I had days when I made millions of dollars in profit for my hedge fund. But the most important day in my trading life was when I first made $1,000 in a day. That was when I knew that I was going to make it – because I knew I could repeat that result.
However, it took me several years to get to that point. From trading just one or two options contracts at the start, you need to steadily build those numbers higher.
Only increase the number of contracts when you have a positive and growing P&L. Put simply, you want to be trading with the market’s money – your profits.
Risk management is one piece of your broader money management strategy.
But you’ve got to look beyond the simple mechanics of buying and selling individual trades. Instead, focus on how you’re going to steadily grow your trading account over time.
Proper money management can take you from being an average trader to someone who can last over the long term.
Happy Trading,
Larry Benedict
Editor, Trading With Larry Benedict
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