A trader\'s money management system

c05 JWBK182-McDowell April 25, 2008 15:51 Printer: Yet to come

40 A TRADER’S MONEY MANAGEMENT SYSTEM

The masters will have a deeper understanding of loss and losing trades.

They no doubt already know their ratio of wins to losses, average dollar win

to average dollar loss statistics, and then some. They may have developed

what we call “The Trader’s Mindset” and possess superior trading psychol-

ogy and confidence.

But, even the master will on occasion forget this very obvious fact that

“not every trade will be a winner.” This temporary amnesia might occur

after a string of one substantially profitable trade after another. Even mas-

ters can fall prey to the illusion of being invincible every once in a while,

and then they will be vulnerable to emotional trading.

We are all human, so no matter how expert we become, and no matter

how fantastic our profits are, we need to remember the root of all trading

evil—that is, the evil of forgetting to fully acknowledge and accept the risk

of potential loss in every trade.

MAYBE, THE WORST THING THAT

CAN HAPPEN IS TO HAVE A

STREAK OF WINNERS IN THE

VERY BEGINNING

It usually takes a while for the novice or beginner to fully appreciate the

importance of recognizing that not all trades will be profitable and that

they won’t be right every time. Sometimes the worst thing that can hap-

pen to eager, and often very intelligent, investors entering the markets and

making their first trades is to have a winning streak right from the start.

Then they really believe all the infomercials that show you how to get

rich quick.

As a beginner, they may be a little sloppy and may have poorly calcu-

lated their stops or have used no stops at all. They may have taken on far

too much risk for their current portfolio size. The winning trades will, in

effect, reward them for bad behavior and will give them the false sense of

security that they know all there is to know about trading, and they are

invincible.

You’ve seen all the disclaimers (including the one at the front of this

book) that say “Past performance is not a guarantee of future results.” That

means if you have a few big winners, you are not “guaranteed” to have

winners for the rest of your days.

The market is a living, breathing entity. It has ups and downs, bulls and

bears, and if you get caught off guard, you can get a swift kick in the butt.

So a word of caution to the novice traders reading this chapter: I want you

to be profitable beyond your wildest dreams, but you must never let your

guard down. Keep your eye on your money management.