9. MONEY MANAGEMENT AND RISK CONTROL

Almost every person I interviewed felt that money management was even more important than the trading method. Many potentially successful systems or trading approaches have led to disaster because the trader applying the strategy lacked a method of controlling risk. You don’t have to be a mathematician or understand portfolio theory to manage risk. Risk control can be as easy as the following three-step approach:

  1. Never risk more than 1 to 2 percent of your capital on any trade. (Depending on your approach, a modestly higher number might still be reasonable. However, I would strongly advise against anything over 5 percent.)
  2. Predetermine your exit point before you get into a trade. Many of the traders I interviewed cited exactly this rule.
  3. If you lose a certain predetermined amount of your starting capital (e.g., 10 percent to 20 percent), take a breather, analyze what went wrong, and wait until you feel confident and have a high-probability idea before you begin trading again. For traders with large accounts, trading very small is a reasonable alternative to a complete trading hiatus. The strategy of cutting trading size down sharply during losing streaks is one mentioned by many of the traders interviewed.