Tuesday, April 15, 2014

The IMPORTANCE of Money Management / Position Sizing

The main reason why money management / position sizing is extremely important is capital preservation ….. to avoid the risk of ruin from a losing streak.
So long as you have the money / capital to trade, you would still have a chance to recover your losses. However, if your capital is gone, you would have no chance at all to recover, as you have no more money for trading.

You may have a high probability trading system that gives you 70% probability of winning. But without sound money management system, you might still get wiped out of the game after unfortunate losing streaks.
A 70% win in 100 trades does not necessarily mean you would win 7 out of every 10. You will not know which 70 out of the 100 trades will be the winners. It is possible that you lose the first 30 trades consecutively and then win the remaining 70, which still gives you a 70% winning system. However, when that happens, will you be still in the game if you lost 30 trades in a row?

This is the reason why money management is very important. No matter how good your trading system is, you could still be facing a losing streak. Hence, you need to set a sound money management system, which will still allow you to stay in the game even if you go through a horrible losing streak.

In view of the above, there are at least a few basic things that you should consider when setting Money Management rules:
1) Draw downs.
2) Considering your Risk Tolerance.
3) How long your capital can last.

In the next posts, we’ll discuss the above topics further.

Continue to: Things To Consider in Setting Money Management Rules - Part 1: DRAW DOWN.

Go back to: OBJECTIVES of Money Management or Position Sizing.

To view the list of all the series on this topic, please refer to:
Money Management / Position Sizing

Related Topics:
* Understanding Implied Volatility (IV)
* Understanding Option Greek
* Understanding Option’s Time Value
* Learning Candlestick Charts
* Options Trading Basic – Part 1
* Options Trading Basic – Part 2