In fact, in a highly simplified form, the entire trading process can be reduced to two main components of money management:
- Determination of the size of the position to be opened;
- Execution of a deal (opening, holding and closing a position).
The solution to the issue of the size of the position to be opened, entirely and completely, falls on the shoulders of such an area of the trader’s knowledge as Money Management . It is the money management rules developed by the trader and included in his trading system that should determine the percentage of risk that can be embedded in each specific transaction. And already based on the permissible level of risk for each position, its size is also determined.
The rules for opening, holding and closing positions should also follow from the trader’s trading system. It is the trading system that should provide answers to all questions that arise in the trading process. However, there are a number of simple rules that can be considered universal and suitable for most trading systems. It is about them that will be discussed below.
Position opening rules of money management
- A position should be opened only when you have at least one main and one confirmation signal. Never enter a trade based on one signal, no matter how reliable it seems to you, wait for its confirmation.
- When opening each new position, make it a rule to document the following parameters in the trader’s diary:
– The set take-profit level (the price at which you are ready to close the position to take profit).
– The set stop loss level (the price at which you are ready to close the position to limit losses).
– The time during which you can keep the position open, and after which you will close it.
– The conclusions of the analysis that prompted you to open this position.
All this information will help you at the stage of analyzing the results of your trading when adjusting the trading system. Any, even the most perfect trading system needs regular adjustments. After all, in this world, everything flows, everything changes, and the stock market, of course, is no exception to this global rule.
- Try not to open positions against the trend, and if you open, then do it carefully and for a short time. It is always better to keep up with the market, as it is impossible to outsmart it. You can predict, but you cannot outsmart. It is not for nothing that traders have developed the following proverb: “The trend is my friend”.
- When opening positions in a sideways trend (with a flat), give preference to price rebounds from support / resistance levels that form a flat channel. And if you decide to trade on a breakout, then place tight stops.
Position retention rules of money management
- Hold open positions only if the market situation does not contradict the conclusions that prompted you to open these positions. Novice traders often have a situation when the current price chart for an open position has long refuted all the prerequisites that prompted its opening. For example, a long position is opened on a new wave of an uptrend, and this wave, in the end, did not continue the upward movement, having passed into a flat. In such cases, you do not need to wait for the weather by the sea, but you should immediately exit the trade
- Hold open positions if the loss on them is below the calculated value determined by the stop loss level. Everything is clear here, always set the levels for limiting losses and if the price reaches them, do not hesitate to exit the trade. It is better to always do it automatically (read more about this here: “ Stop Loss Order“).
- Hold open positions if the profit on them is below the calculated value determined by the take profit level. An early entry from a position, due to the fear of losing the small, paper profit that has already been earned on it, negatively affects the value of the expected profit. Or, in other words, it can lead to a loss based on the results of trading for a certain period.
Position closing rules
- Close the position after the expiration of the time allotted for its existence. If the logic of opening a position assumed its relevance during a specific time period, then you should not contradict it. It is not necessary to hold the position to the end for reasons of only one hope of its profitability.
- Close the position upon reaching the specified profit level (take profit). You should never be greedy. If the preliminary analysis of the traded financial instrument allowed you to place certain stop loss and take profit levels, then do not contradict your own logic and close the position at predetermined prices. Remember that it is unrealistic to work out every price movement to the maximum; you cannot earn all the money, as they say.
- Close the position upon reaching the specified allowable loss level (stop loss). Never move the once set stop loss towards the loss. You can move towards profit, but absolutely not towards loss. Many traders who have merged their deposits realized this only through their bitter experience. Don’t repeat their mistakes.
In light of the above, you may find the following material useful: “ How to correctly place a Stop Loss order and a Take Profit order ”.