Trading / Investing

A Smart Money Management Tip for You

4 Min Read

I want to teach you a smart little money management tip for protecting your capital against unexpected disasters; like the failure of some brokers recently following the Swiss National Bank announcement, which left many people without access to their trading capitalBut first, let me tell you a funny story with an important moral.Earlier this week I was out for dinner with a good friend of mine and his family. We had just enjoyed a lovely meal at a stylish restaurant near Covent Garden (London) and the waiter was busy collecting the plates.That’s when disaster struck…I could see it all happening in slow motion (why does time slow down when accidents are happening?) but I was powerless to stop it.

Going, going, gone!

The waiter had stacked a few plates and bowls on his arm - I could have predicted a problem arising when I noticed how the stack resembled the Tower of Babel. As he leaned over to collect the last plate, a poorly balanced bowl of oil and vinegar collapsed from the top of the pile… with the contents being delivered all over the brand-new jumper of my friend’s 17 year old daughter.You can imagine what happened next. Needless to say, her mum was not happy and the waiter seemed to shrink by at least a metre (poor guy).As I sat and enjoyed the entertainment provided by the tension of the situation, I realised there were two important lessons from all this:

  1. Never, ever (ever, ever, ever!!) get on the wrong side of a Maltese woman. I was truly scared for the waiter.
  2. Unexpected problems happen… well… unexpectedly! So we need to protect or prepare ourselves as much as possible in important situations. If the waiter had reacted in the right way, he would have avoided the murderous glare.

So how does this relate to trading?

This clearly relates to trading (point 2, obviously), as we are dealing with real money, which is important.We always focus on protecting ourselves by sticking to a strategy, using stop losses, analysing situations and so on. But how can we protect ourselves against unexpected situations like a broker going out of business or a stop loss not being triggered?I’m going to share with you a smart strategy to protect yourself. Some of you won’t like this and therefore it won’t be for you, but some of you are going to love it. Have a look below to find out.P.S. The owner, who looked extremely nervous, did give a discount from the bill at the end of the night and I got some free entertainment from the situation – win/win! That’s how I like to trade.

Bonus Content

The Drip Feed Money Management ApproachThis approach isn’t for everyone and should only be applied if you see a genuine need for it. However, even if you don’t use this approach, I hope you can at least incorporate aspects of it into your money management, to ensure you aren’t leaving yourself wide open to external risks.I will later explain who this is suitable for and the positives/negatives, but first let me explain the method itself. It will seem simple at a first glance, but the beauty is in understanding what this small change will enable you the freedom to do.If you are live trading, you should already know how much of your account you will allow to be at risk per trade, per day, per week, per month and per market. If you don’t – stop trading and plan those percentages immediately!The idea of the Drip Feed Money Management Approach is to take those percentages and to enforce them in a way that avoids accidents and external faults taking hold of your account and taking you to the cleaners.Simply put, you will be ‘drip feeding’ your trading account with your allocated risk. You will need to decide whether that is per day, per week etc. based on the turnover of your system, how actively you trade and how quickly you can get money deposited into your account (some brokers instantly credit your account, which is ideal).

dripping-pipe

The best way to explain this will be with an example, so let’s take a look at one:If I know that the maximum I am willing to lose in one week is 3%, this is the amount I will have available in my account for trading each week. This can then be replenished, if necessary, at the start of each week (or partial funds withdrawn if profit has been made).This is the simple explanation for unleveraged trading. Of course, if you are using leverage, you will need to make sure you have enough to cover your margin requirements on the amount of your account you will be willing to risk.The rest of your money will be kept in a bank account with instant access, or with some funds held in a safe, conservative investment that is not putting your funds at risk. DO NOT hold the rest of your funds with the same broker, even if they offer a separate bank account option.This same approach can be replicated if you want to focus on having enough funds in the account for your monthly risk limit, daily risk limit or even individual trade limit if you are not trading frequently.It seems extremely simple doesn’t it? Almost so simple, in fact, that there doesn’t seem to be a perceived benefit, just a lot of additional admin work. So let me now explain the benefits.By not having all your money held with the broker you avoid the following situations:

  • Issues with the broker (insolvency, liquidation etc.) meaning you have a delay on accessing your funds.
  • Misplacing or forgetting to place a stop loss wiping out more of your account than you intended.
  • System errors resulting in stop losses or trade closures not being executed in time, or at all.
  • Avoid the temptation of overtrading, chasing losses or risking more than your system allows.

There are also two additional benefits for some traders, which I will explain in more detail in a minute:

  • Account less susceptible to market manipulation.
  • Account set up to accommodate high risk or overleveraging.

What are the negative aspects of taking this approach?

  • Extra admin work of arranging the transfers to and from the account.
  • Less agility in the market if you want to take advantage of a rare, sudden opportunity.
  • Psychological impact of not being able to see your overall account.

So who is this money management approach for? Well, really it’s for everybody. You don’t want to leave all your eggs in one basket and have an additional risk on your overall account which you have no control over. Trading carries enough risks already.In addition to this, I also added two extra benefits which I said were only for some traders, which may not make sense immediately. This is for traders who either enjoy taking bigger risks, or realise they find themselves taking risks without meaning to. If you only assign the amount of capital in the account that you are willing to risk on one trade, you can avoid the need for using a stop loss. This means you can avoid ‘stop loss hunts’ and any type of market manipulation. Have you ever had a stop loss in the market and realised it was triggered without the price ever seeming to reach that value? Exactly… well, not having any stop loss will avoid this. Instead, you will simply be allowing your ‘account’ to burn out as a stop loss.As for taking higher risks or overleveraging – I see a lot of people doing this, whether they mean to or not. In fact, it’s probably the biggest reason for amateur traders losing money. People get greedy and don’t control their risk levels. If you only have a certain amount of capital available in your account, you can overleverage as much as you want, but will never run the risk of running up a bigger loss than you originally intended. Sometimes in ‘the heat of battle’ we will be more willing to take risks that we wouldn’t dream of doing in advance. This helps you control your trading with your rational mind rather than your irrational, adrenalin-driven mind.Are you starting to see the benefits now? Good. You may not agree with some of the points I have mentioned, but believe me, I have seen this approach save many traders in the past and I hope you will also consider at least incorporating this type of thinking into your trading too.Always do your calculations and trade in a controlled manner. I was once taught one of the most valuable trading lessons in just one sentence “if you trade well and how you’re supposed to trade – it’s bloody boring”.