Money Management has different meaning in different context and the best definition with respect to trading will be
Money Management has different meaning in different context and the best definition with respect to trading will be
1. what is your equity (trading capital)?
2. what percentage of your equity is risked per position
3. what is the expectancy of your system or in other words how much do you win when you win and how much do you lose when you lose and how many times do you win out of all trades.
It is easy to define 1. above though people have the tendency to start with some little amout and keep adding on to that. That is strongly discouraged. Define your complete equity in the very beginning and set that amount aside.
It is a general rule that you should not risk more than 2% in any one trade.
If for eg., you have an initial equity of 100000, then 2% of that comes to 2000.With that let us come to a trade
Sell BATAINDIA Entry - 143
Exit - 137.1
SL - 150.1
So we have all the required information. How do we trade this?
First let us talk in terms of percentage.
Profit potential 4.12%
Loss potential 4.96%
In order to initiate the trade, we have all the information required except the number of BATAINDIA stocks that we can go short.
It is easily computed as
2000 / (SL - Entry)
= 2000 / (150.1 - 143)
= 2000 / 7.1
= 281.69
Always rounddown the number of trades. This becomes 281 then.
If your initial equity is 100000, and for a risk % of 2%,
go short 281 shares of BATAINDIA at 143, SL at 150.1
You must be wondering why we have not talked anything about the Exit or the profit potential. After all we trade only to reach that target and not the SL.
Remember the saying, "Take care of your losses and profits will take care of themselves"
Anyway, we will also see how significant the profit target is and that is where we come to point no. 3
Suppose your system generates 4 trades a day and 3 becomes profitable out of that, then
the success rate is 75%
On an average if your profit % as well as your loss % is say 4% on any trade,
then your expectancy is
( 75% * 4 - 25% * 4 ) = 2
This means for every Rs. 100 that you risk, you stand to gain Rs. 2
