The Rules of Money Management
One of the most challenging areas when it comes to anyone's trading habits is the manner in which they handle proper money management. I know I've discussed this issue with you before but I really think the rules of money management can't be stressed enough.
Keep in mind that there are rules for just about everything we do in life and rules help to reinforce our chances for success. Here we are in the spring of 2007 and I'm sure many of you are gardeners. In order to better insure success in your garden, you must make sure you plant during the proper season and use the proper fertilizer to increase your odds of success. Practicing good money management, when it comes to your investments, is also of vital importance when it comes to improving your chances of becoming successful as a trader.
One thing to keep in mind before selecting your trade is to determine the trend and make certain you set a stop loss. This will allow you to determine whether you should get into the trade in the first place. If you decide to take the trade, setting your stop loss order will also determine how long you will be willing to stay invested. Proper money management from the start will establish how much you can spend on one trade and more importantly, how much you'd be willing to lose should the trade go against you.
Make sure you always trade with a 'Risk to Reward Radio' of 1½ to 1 or better on every trade you make. This is the relationship between the degrees of risk involved in an investment to the anticipated return. Not managing this aspect of the trade is one of the primary reasons many investors fail. By neglecting the risk associated with any investment opportunity, your ultimate reward just might be placed in jeopardy. Make sure that your trade is something you can live with on a personal level. Only you know your tolerance level and never, as they say, "trade the farm." Don't put all your eggs in one basket and live to trade another day. Examine your personal risk tolerance level. Discover at what level are you willing to let an investment go.
Be sure to set realistic goals that can be achieved within reason. Don't expect to make boat loads of money right away from your trading accounts. You might consider using a demo trading account at first just to help you develop a certain amount of consistency before going "live" with real money. Always remember that emotions and investing don't mix. Consider each trade as a business transaction and do not get emotionally attached.
Remember to only trade with money that you can actually afford to lose. Trading with your retirement funds, home equity loans, loans from your 401(k) plan, or the kids' college money is a very foolish thing to do but it is a common practice among beginning traders. When you invest or trade, be certain to only use money that won't affect your current lifestyle if it is lost.
Like I said, although we've talked about proper money management in the past, it definitely bears repeating and there is no assurance that even if you use proper money management and follow all the rules of trading that you'll succeed in every investment you make. One thing is certain; I have personally found that practicing effective money management helps develop more consistent trades that are more likely to become successful.
Happy Investing!
Originally published in the Outspoken e-newsletter.