V.10:6 (261-264): The Basics Of Managing Money by Robert P. Rotella

The Basics Of Managing Money by Robert P. Rotella

A trader can score that one big win, but it's all for naught if he can't hold onto his profits. Money management is the step both before and after trading, the study of risk and reward and how best to utilize investment capital—and keep it. Here's an excerpt from The Elements of Successful Trading, scheduled for release in June 1992 from New York Institute of Finance.

Money management is the evaluation of risk and reward in trade or portfolio and determining the most efficient use of investment capital. Money management is the study of risk and return; we are trying to get the best return for the money we risk. Money management involves these steps:

1. Determining the different kinds of risk in any trade.

2. Deciding how much risk to take on a trade.

3. Assessing the amount of return on a trade for a given level of risk.

4. Deciding whether to accept the return and risk.

5. Implementing the entire process.

This process can be a lot of work, but it is also worth the effort. Money management is important to trading successfully, yet most traders do not understand it. Money management is important to success for practical reasons. How much money should be risked on a trade? If a trader risks too much money, then there is always a fair chance of losing all the capital in one disastrous trade or a series of losing trades. On the other hand, if the trader risks too small an amount of money, then the capital will be underutilized and the trader will not achieve as high a return as may be possible. There is not much sense in trading commodities and obtaining returns equivalent to Treasury bills because the risk is so much greater but the return is not.