To begin with, let me destroy a common myth: there are no trading systems that will pick winning trades one hundred percent of the time. Despite this fact, many novice traders undertake a determined search to find the perfect indicator(s) that will lead them to trading success. Even though this may sound absurd, you too may search for the silver bullet to slay the market. So why do most market participants search for this perfect entry? I believe the reason is a subconscious one.
The problem is that focusing on your entry you get a feeling of control. The point you have chosen to enter the market is the point at which the market is doing exactly what you want it to do. As a result, you feel like there is some sort of control, not over the entry, but over the market. This is where most traders go wrong.
Let me save you the time and money with this IMPORTANT TIP!
No such perfect indicator exists. It does not today, never did and never will.
Please save yourself hours upon hours of your valuable time… and devote yourself to a more fruitful activity.
Once you are in a position in the market, the market is going to do whatever it wants to do. We cannot control the direction of the market, or the extent of the move. There is only one component we do have control over and that is your money management. Here lays the true Holy Grail of trading.
Jack Schwager's book Market Wizards makes some intriguing statements about money management. In Market Wizards, Jack Schwager interviews some of the world's top traders and investors. Practically all of them talked about the importance of money management. Here are a few sample quotes:
| | "Risk management is the most important thing to be well understood. Undertrade, undertrade, undertrade is my second piece of advice. Whatever you think your position ought to be, cut it at least in half." - Bruce Kovner |
| | "Never risk more than 1% of your total equity in any one trade. By risking 1%, I am indifferent to any individual trade. Keeping your risk small and constant is absolutely critical." - Larry Hite |
| | "You have to minimize your losses and try to preserve capital for those very few instances where you can make a lot in a very short period of time. What you can’t afford to do is throw away your capital on suboptimal trades". - Richard Dennis |
Despite its importance, money management still remains relatively unknown by many traders and investors around the world. The reality is that most people look at trading as a game of odds. True it does contain odds, but odds alone do not tell the whole story.
When you look at trading systems, are you someone who only looks at the ratio of wins to losses? After all, it seems logical that a system that generates 8 winning trades out of 10 is better than one that only has 4 out of 10… right? wrong.
The best way to look at trades is this. Winning and profiting are two totally different things. If your system has an 80% odd of winning $1 and a 20% chance of losing $100, this is a negatively biased system, or in other words, has a negative expectancy. Therefore, despite the fact that you may experience many winning trades, in the end you are bound to lose everything. Stringing together a couple of dozen winning trades, valued at $1 each, followed by a single loss of $100 will guarantee a trip to the poor house. Expectancy is calculated as:
(% of Wins x Average Win Size) – (% of Losses x Average Loss Size) = Expectancy
So in our example we can see that:
(80% x $10) – (20% x $100)
$8 - $20 = -$12
This strategy has a negative expectancy a system that has a positive expectancy could lose 80% of the time, yet still be profitable.
Using the same numbers:
(20% x $100) – (80% x $10)
$20 - $8 = +$12
Is this example too far fetched? No. I have witnessed day in day out the common trading patterns of would be professional traders. The instinctive action is to take profits the moment they appear, and ride losses until they are unbearable. That is exactly what an 80% win to 20% loss negative expectancy system looks like. They take lots of small wins, but lose their profit and more to the few losses they let become huge. The major reason why people fall prey to this is because they do not have a clearly defined money management rules.
So what is money management?
Simply money management is a set of rules and guidelines that keep your risk at a level at which you are comfortable with. It includes rules that define exit points, maximum loss per trade, maximum exposure and other key variables that affect your capital allocation.
Money management answers the questions such as:
- When should you exit a trade?
- What is the exact amount of risk you accept for each trade?
- How large should your position sizes be?
Although, these questions may sound simple, what makes the answers so critical, is that if you get it “right” you can be wrong 50% of the time & still make money. Money management rules truly are your safeguard against financial ruin.
At this point, I feel it’s prudent to repeat the goal of the Ultimate Trading Systems - “to provide you with a step-by-step road map to designing profitable trading systems.” Remember, if I make a suggestion for a resource, it's only because it will speed up your success…
My mentor in this area of trading was an amazing trader and psychologist called Dr Van Tharp. And although I recommend his book - Trade Your Way to Financial Freedom - many people feel it is simply out of their reach. The language he uses and his ideas can, at times appear, very complex and sophisticated. I must admit, I did have to read and re-read this book numerous times to fully understand his concepts.
It has taken me years to simplify these rules and although it was a tough road to pave, the rewards have been worth it. The good news is you do not have to go down the same long road I did. After countless clients asking for coaching on this topic, I decided to create a system that takes you through the process of designing excellent money management rules step-by-step. I named it “Trading Secrets Revealed”.
Trading Secrets Revealed really is the first package of its kind, since it reveals the secrets I, and many other professional traders use to consistently make profits from the markets… best of all it does so in a no B.S. no fluff, no nonsense fashion.
Don’t take my word for it though, the response to this package has been phenomenal… Here is what one client said:
| Trading Secrets Revealed Testimonial "I wanted to let you know that since I read your material in early May, I have implemented several items, including limiting my loss to 2% of float and using your initial and trailing stops, into my own trading system. As a result I definitely have more confidence and less stress about my trades. |
By learning money management you too can achieve results just like these. Again you have two choices, you can either read the complex concepts in Trade Your Way to Financial Freedomor if you’d like to learn these secrets in an easy to listen to audio course check out Trading Secrets Revealed (I’ll even go through in a whole host of bonuses if you do).
At the completion of the program, your next task is to get your money management rules written down.
Similar to your entry rules, excellent money management rules are simple, direct, and leave no room for human judgment. Take the money management rules from Trade Your Way to Financial Freedom or Trading Secrets Revealed and write out exactly how you will manage your risk.
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