Trading is an art that requires a combination of both discipline and analytical skills. When failing to follow the necessary principles, traders are set to lose massive sums of money.
For beginners, setting the proper foundation is paramount for ensuring growth and excellent outcomes from the market. Some of these principles could include choosing a good trading strategy. While different people employ different methods, a proper money management strategy allows a trader to live to fight another day.
What is a Money Management Strategy?
In a prediction market, money management can be defined as a trader’s process to oversee how they utilize and save money. This concept provides traders with a framework to preserve their trading capital.
Over the years, the money management strategy has helped many traders avoid bankruptcy by planning and limiting how much they are willing to spend in any given market.
It allows traders to either increase or decrease their position size, making it possible to mitigate risks and maximize profits. This strategy provides a balance for too aggressive or too conservative traders, helping them achieve their goals.
The money management strategy can be divided into two, the martingale method and the anti-martingale method. The martingale method embraces the concept that there is bound to be a profit in a trader’s life despite their losing streak (a losing streak won’t last forever). This concept is not popular among traders since it involves risking everything to get small profits or break even.
On the other hand, the anti-martingale method allows the trader to increase or decrease their position size with increased profits or losses. Many traders prefer this method since it opens up opportunities to mitigate what happens to their trade.
While this concept allows traders to control their losses, it should in no way be mistaken for risk management or position sizing. In addition, the money management strategy does not have the power to turn a lousy plan into a winning jackpot.
Ideally, each trader should choose a money management system that best suits their trading needs. Here are a few money management practices to consider as a trader:
Allocation of funds
Allocation of funds plays a significant role in ensuring a trader prioritizes urgent matters like paying necessary bills. In a prediction market, this practice allows traders to only trade funds they are willing to lose. Allocation helps one divide their asset in retrospect to the most urgent need.
Allocation of funds also helps a trader know when they have additional fees to invest. Usually, investing the same amount limits a trader’s growth.
Overall, allocation of funds eliminates the pressure of winning on the trader’s part, which could go a long way in ensuring they make the right decision.
The best way to allocate funds is to use tools like a money management spreadsheet or record the inflow and outflow of funds.
Use position sizing to define risks per trade
After fund allocation, position sizing helps a trader divide or manage the funds set aside for trading. It helps a trader decide how much money they are willing to spend per trade. In addition, having a tracking spreadsheet makes it easier to trace and learn mistakes made, which trade proved to be most rewarding, and so forth.
Adjust strategies with each trade
Each trader is different from the next. Despite the similarities, traders should avoid using the same strategies across their trade. Using the same strategy can sometimes cause habitual practices that might cause significant losses in a market change. It is highly advisable to make different rules for different trading markets. The rules should highly rely on fundamental and technical analysis.
Using a Risk-to-Reward ration
Basic training on trade requires traders to aim at winning trades that are twice as big as the losing trades (the 2% rule). Some traders will advise on having this number go higher to about 3:1.
However, experts will often advise a trader to be consistent in their risk: reward ratio. The balance between losses and rewards will vary depending on the market. At times, a market might be profitable despite there being more losses than wins.
Use stop losses
One practice that comes in handy when the market shifts for the worse is a stop loss. This tool allows traders to limit the number of losses a trader can take during a trade. Ideally, a stop loss works by ending the trade once the limit loss is reached.
These tools help traders from losing more money when their positions dip even further. Another added advantage of stop losses is that they help eliminate the need for traders to monitor their investments all day long.
Most trading platforms have inbuilt stopwatches. There are many types of stop losses, but the four main ones include equity stop, chart stop, volatility stop, and margin stop. However, this practice can be frustrating when a trader sees a stop loss triggered only to turn around and hit the take profit level.
Choosing a money management strategy might be easy but following it through is another thing altogether. The difference between a trader and a successful trader is that one follows through with the set practices and rules while the other spends all the time doing the research only to follow a different route.