A trader\'s money management system

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c02 JWBK182-McDowell April 25, 2008 15:39 Printer: Yet to come

16 A TRADER’S MONEY MANAGEMENT SYSTEM

Frankly, it could happen to anyone, because the market is a volatile, pow-

erful and unpredictable place. The power of the market can overcome

even the most experienced of market participants. Sometimes, it’s like a

tidal wave—you may even see it coming but you can’t get out of the way

in time.

The 1929 and 1987 market crashes, the many housing bubbles over the

years, Pearl Harbor, September 11, the technology bubble of 2000, the col-

lapse of Enron—the list goes on and on. Some situations are bigger than

life, and it is those situations, in addition to the day-to-day unpredictable

nature of the market, that sound risk control can help you manage. It is all

about calculating probabilities and making sure they work for you and not

against you.

It is similar to having an insurance policy—so, yes, your house burned

down or got blown away in a hurricane. But at least you have insurance

money to rebuild your life once you have overcome the emotional shock

and devastation. A stop-loss exit will cost you money along the way just

like the cost of insurance, but you didn’t lose it all and you can regroup and

rethink your position at the end of the day.

Consider that position in contrast to not having a stop loss in place and

instantly losing everything you have. Basically, a money management plan

is a cost of doing business, just like insurance that you no doubt currently

have and understand the need for. Consider a change in perspective and

see money management as insurance and a cost of doing business. It may

take on an even greater meaning and value to you.

AN INSURANCE POLICY FOR TRADERS AND

INVESTORS

The principles that work for you in day-to-day life can also work in your trading

and investing endeavors. Putting a money management plan into place may

create some additional costs to you in both time and money. But these costs

can work to your advantage in the same way as paying a monthly insurance

premium cost can protect you against catastrophe for a variety of situations in

your day-to-day life.

We’ve listed a number of common insurance policies that you may be ben-

efiting from today. If you can see how these policies help protect you from dis-

aster, you may find it easier to see the benefit in also insuring that you protect

yourself from the potential risks that are inherent in the financial markets:


Automobile insurance for both bodily injury and car repair and replacement

due to an accident


Home insurance for both bodily injury and home repair and replacement

due to an accident or catastrophe