The Importance of Money Management
There are rules for everything we do in life. Whether you're learning to play tennis, sail a boat or plant a garden, there are certain rules and policies that simply can't be ignored if you expect to succeed. Rules bolster our success. For instance, if you're planning to start a garden, planting during the proper season and using fertilizer will increase your chances of success. So it is that practicing good money management, when it comes to your investments, is of paramount importance when it comes to improving your chances of increasing the value of your portfolio.
Every day on my national radio program, people say they stayed in a stock too long because they "felt" it wasn't the right time to get out. So, they end up riding the issue into the gutter and losing money. How many times did we see this happen at the end of the tech bubble? How many lessons should we have learned that apparently went disregarded?
We are constantly discussing the importance of proper money management in all of our publications, web sites and radio broadcasts. As a quick reminder, let's touch on just a couple of the important rules of good money management.
Never, ever, ever trade without a stop loss. This is an instruction to your broker to close out your short position -- buy stock to replace the shares you borrowed -- if your losses reach a certain percentage of your investment. It's kind of like an insurance policy that will insure you stay in the game if the trade goes wrong.
Always trade with a risk reward radio of 1½ to 1 or better on every trade. This is the relationship between the degrees of risk involved in an investment to the anticipated return. Examine your personal risk tolerance level. Discover at what level are you willing to let an investment go.
Never over leverage your account. For companies, leverage is measured by the debt-to-equity ratio, which is calculated by dividing long-term debt by shareholders' equity. For investors, leverage means buying on margin or using derivatives such as options, to enhance return on value without increasing investment.
Set realistic goals that can be achieved within reason. Don't expect to make tons of money trading right form the start. Always remember that emotions and investing just don't mix. Treat each trade as a business transaction and try not to become emotionally attached.
ONLY trade with money you can afford to lose. Trading with your retirement funds, loans from your 401(k) plan or the kid's college money is very foolish but it is a common practice among beginning traders. When you invest or trade, be certain to only use money that won't adversely affect your lifestyle if lost.
These are just a few of the important rules of money management that should be used every time you make a trade. There is no guarantee that even if you follow the proper rules of trading, you'll succeed in every investment you make. But one thing is for sure; good money management levels the playing field and allows you to make consistent trades that are more likely to be successful.
Happy Investing!
Originally published in the Outspoken e-newsletter.