A trader\'s money management system

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

42 A TRADER’S MONEY MANAGEMENT SYSTEM

PERFECTIONISTS BEWARE

If we now agree that every trade will not be a winner, how will the perfec-

tionists reading this chapter be able to cope? If it means that there will be

times that you are wrong, can you live with that?

We have a lot of clients that are fighter pilots, airline pilots, you name

it. When we talk to them, it is interesting because they are the first to under-

stand all the concepts ofpaper trading(just like flight simulators), follow-

ing the trading rules (just like preflight checklist), and having discipline.

But the one thing these pilots have difficulty with isstop-outs. When

you’re 30,000 miles above land, there is no room for error (or stop-outs),

or for being wrong, because when you are wrong it usually means you will

crash and burn. They have little tolerance for imperfection.

So when they get stopped out, they have to rewire their thinking to

remember that a stop-out is only a minor flight-plan course correction—it

is not crashing and burning. Maybe a stop is the equivalent to turbulence

that you eliminate by adjusting your altitude.

For the perfectionists, remember that stop-outs are a normal part of

trading, and being wrong is not the end of the world, especially if you make

the appropriate corrections in a timely manner. It is the big picture that

matters at the end of the trading day, or week, or month, or year.

Progress counts, too. If you are losing $1000 a month right now be-

cause you are in the learning phase, when you reduce that monthly loss

to $500 you better pat yourself on the back. Remember, any step toward

greater profitability is a positive.

WHAT IS THE ANSWER?

If we are never going to get 100 percent perfection in our trades, then the

answer to “How can we maintain profitability?” is the age-old adage of “cut

your losses short and let your winners ride.” That will require you to main-

tain discipline and adhere to eight guidelines:

1.Find a trading system or approach that is compatible with your person-

ality, experience level, and comfort zone.

2.Paper trade (see Appendix C, The Art of Paper Trading, in this book)

that system to determine what your win ratio and payoff ratio are

(not what they are for the person that recommended the system to

you). These statistics will be needed when you design your money