Money Management in Trading

Money Management

If emotions are the downfall of most investors, then everything possible needs to be put in place to eliminate emotional aspects. That process should be car­ried through to the money management of a portfolio. Unfortunately, as debili­tating as fear and greed are to most investment decision-making processes, the human ego is also a major hurdle. Of course, we are all smarter than the aver­age investor. Unfortunately, that thought process usually skews good money management.

As important as it is to take the emotions out of when to buy and when to sell, it is also important not to have egotistical reasons to stay in a trade. The easiest way to eliminate that factor is to pre-establish and maintain uniform position sizes. Why should each position be the same size as the next position? To keep from putting our emotions into the decision-making process!

For example, after going through a scanning process, an investor finds the perfect trade. It has every confirming indicator in the exact correct conditions. The chart suggests this could be a killer trade. What is the first inclination?

Because we are a little bit smarter than everybody else is, we put 1 1/2 times the normal investment funds into this perfect trade. What has just been cre­ated? A position that has a little bit of our ego involved. Reality check! What has occurred when all the indicators have aligned perfectly? A trade where the “probabilities” are extremely high that it will be profitable. Unfortunately, the qualifier to this statement is the word “probabilities.” The best trade setups still have the possibility of not performing.

After putting a more than normal allocation of funds into this trade, a new mental dynamic occurs. “This trade should go up” because our mental pro­cesses said it should go up. What happens when the trade does not perform as expected? We give it another day or two longer than we should because our ‘smarter than average’ investor prowess expects the price to eventually do what we evaluated it will do. Instead of making a decision on a ‘unit’ of our portfolio, we are trying to prove ourselves right and hold a position too long. Money management involves simple and mechanical processes for correctly executing the positioning of a portfolio.