A trader\'s money management system

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c07 JWBK182-McDowell April 25, 2008 15:58 Printer: Yet to come

62 A TRADER’S MONEY MANAGEMENT SYSTEM

IMPORTANT NOTE: For some advanced traders, it is beneficial to

risk more than 2 percent of their trading account. The amount these

traders risk must be carefully calculated depending on their proven

historical performance statistics. See Chapter 9 for the formulas to

determine if your payoff ratio and win ratio performance warrant a

higher risk than 2 percent.

THEDOWNSIDETOPOORLYSELECTED

STOP-LOSS EXITS

Having the discipline to set a stop-loss exit and adhere to it is better than

not, even if it is a poorly selected stop. With that said, the better your stop

strategy is, the more profitable you will be. So it is crucial from a revenue

standpoint to refine your approach.

The most common down side to a less than perfect stop-loss exit is

that you will get stopped out on the correction and then the market will

race back in the direction you initially were betting on. Repeated stop-outs

can also eat into your bottom line by racking up commission fees.

Keep in mind, there is no perfect stop and there is no way to time the

market perfectly. Your goal is to get the probabilities to lean in your favor.

With experience, you will incorporate a variety of live market lessons into

your own approach. This experience is the key to increasing your prof-

itability curve. But remember to always select your initial stop-loss exit

prior to entering the market.

THE MARKET HAS TO BREATHE, AND SO

DO YOUR STOPS

The market is a living, breathing thing, and it rarely goes entirely in only

one direction for an extended period of time. Rather, it goes in one direc-

tion, has a correction, continues back in its trend direction, has another

correction, and so on. It inhales and exhales, it goes up, it goes down, and

you need to give it the freedom to do that. Even in a sideways market, there

are ups and downs; it is like the ebb and flow of the tides, back and forth.

It is nature, and you must learn to ebb and flow with it.

This is why setting stops on key levels of price support is crucial. Usu-

ally key support levels represent significant market realities occurring with

enough trade volume to warrant a stop loss level.