Money Management Issues - How to use a set percentage of your trading funds

In the previous post we reviewed the more traditional approach to money management by placing stop on your stock trades or a mental stop using your own technical analysis on option trades. Just for a short review, these types of stops can be placed at certain percentages or by using your own analysis and critical points locations or levels. All of these methods will work some of the time and fail at others. There is no set formula or way to handle this issue that will always work 100% of the time without fail. It is just the nature of the beast.

This method and might I say simpler method is to use a set percentage of your trading funds for each and every trade. Never ever exceed this amount, no matter how good you feel about a particular position or trade. You could use about 4-5% of your tradable funds for each trade. This will allow you to make about 20 trades for some diversification and still have a manageable amount of risk assigned to each. Using this method, no stop loss orders are placed, so you too will have to be fairly confident in your analysis and trading abilities if you follow this method. Using this method would also requires having your own analysis as a back up. When the trade has gone against what you thought would happen - get out. When a level is penetrated further than what your analysis tells you should have occurred - then get out.

By using this method, you can also apply the same rules to options trading as well as the more traditional stock trading. The same rules apply. Make sure you never trade more money than is allowed under the system and spread your money out over 20 or so positions over time. There will be times when you only have a few positions and that's OK. As your analysis is confirmed by the markets continue to take on new positions always following the rule.

This is the very method and we have found that it works out the best over time. Even with both of these safeguards in place there will be times when mistakes are made and the result will be trading losses. This just happens from time to time as we do not have a crystal ball either.

By using this method, it limits your exposure on each trade, whether it is a stock or an option trade. It still allows for a decent amount of diversification and still has a theoretically unlimited profit potential on each and every trade.

Give this method a thorough look and think about some of those past trades you have made that did not turn out as they might have. Think about adopting this method or some variation that suits you and your trading if you tend to put too much money into some of your positions. This will help to prevent just this kind of mistake.