Money management

The name money management comes from the English term money management and translates as "money management." Money management is an integral part of the science of risk management. The specificity of this section is that money management determines the rules of risk management in relation not to a specific transaction, but immediately to all transactions you make and to your deposit as a whole.

Compliance with the rules and principles of money management is a very important part of trading. Currently, there are many computer systems that allow the trader to monitor compliance with these rules automatically, and I urge you to use such systems, since no one can be completely sure that at the most crucial moment he will be able to cope with his emotions. I am telling you this with competence, because at the beginning of my career as a trader in New York, I was in a situation where it seemed that a small one-time deviation from the rules would allow me to achieve trading success. At that time, there were no advanced automated systems that controlled risks, but we used a more serious tool for these purposes: the real person is a former paratrooper. He did not understand much in trading, but did an excellent job with his work, standing guard over acceptable levels of risk and at the root stopping all our attempts to deviate from the permitted limits.

But even if you decide to use a computer system for risk management, you still need to know the rules and principles of money management, since it is about your own money and you must set the basic risk parameters yourself.

What relates to these parameters?

Firstly, the size of the risk of the total deposit per one trading day. Simply put, this parameter determines what percentage of the deposit you are ready to lose in one trading session. It is important that this parameter remains unchanged, even if you really want to expand risk limits, for example, in order to win back the losses received earlier.

I recommend setting this risk indicator to between 1 and 3%. In this case, beginners should focus on the lower limit of this range. The limit of risk allocated per day should be divided between all transactions that you intend to complete in one trading session. Such a distribution of risks in the market is called the beautiful word diversification. But in fact, this term hides folk wisdom, well known even to people very far from the market: do not put all your eggs in one basket. In our case, the rule is this: do not invest the entire daily risk limit in one position. Divide it into three to five positions. Even if you correctly identify the levels, have an understanding of market movements, know how to enter the market and place stops, there are still far from meager chances that the capricious market may go against you at a particular moment. But the likelihood that this will happen immediately in three to five positions will be significantly lower. Otherwise, you are obviously doing something or understanding it in a different way. Therefore, if you received three losing trades in a row during one trading session, it is recommended to stop and devote the rest of the day not to concluding new transactions, but to sorting out flights and preparing for trading the next day.

Your transactions do not have to follow each other and include the same asset. For example, you can immediately conclude three transactions with different trading instruments. In this case, the problem arises of an even distribution of risks between transactions associated with the difference in prices of different assets. To solve this problem, risk equalization is carried out by varying the volume of positions for each instrument.

For example, you trade in shares of Gazprom and Sberbank. The price of Gazprom shares is 140 rubles, the shares of Sberbank - 220 rubles. The price ratio is approximately 1.5: 1 in favor of Sberbank. Under these conditions, risk balancing on the positions of the named shares can be achieved if the ratio of the volumes of open positions is also 1.5: 1. 200 shares of Sberbank and 300 shares of Gazprom (20 and 30 lots, respectively) will create the right balance of risks.

When trading multiple instruments, the risk is initially calculated on a more expensive asset, and then a proportional increase in the position volume for a cheaper instrument is made.

If you mix the trading of Russian instruments with the trading of commodity assets, such as gold, oil, euro / dollar, it should be borne in mind that such trading is best done only intraday, since the prices of commodity assets traded 24 hours a day can happen all that anything for that night, while the Russian market is closed.

The expression of risk parameters in percent allows you to apply these parameters without change to any size of the deposit. Thanks to this, when adding or withdrawing money from your deposit, you do not have to change the rules of money management.

Let's look at a simple example. Let's say your deposit is 1 000 000 rubles. You have determined for yourself that the risk per one day should not exceed 1% of the deposit, which is equivalent to 10,000 rubles. However, in order not to invest all the permissible risk in one transaction, we will distribute it across three transactions. Then the risk for each of them will turn out to be approximately equal to 0.3% of the deposit, or 3000 rubles. Let's say that you want to conclude a deal with Gazprom shares, which at the time of opening the position are traded at a price of 150 rubles. per share.

Based on these initial data and the previously determined standard stop size of 0.2% of the asset price, you can already determine the volume of your trading position that meets the risk parameters.

At a stock price of 150 rubles. the estimated stop size will be 150 × 0.2% = 0.3 rubles. This is the risk per share. Dividing the total amount of risk per trade by the stop (risk) size of one share, we get: 3000 rubles / 0.3 rubles. = 10,000 shares. Since shares are traded in lots, each of which includes 10 shares (for Gazprom shares), it turns out that we can open a position with a maximum volume of 1000 lots of Gazprom. Naturally, since the value of such a position exceeds the size of the deposit, to open to the maximum you will have to use leverage. Now, if the market, after opening a position, goes against you and your protective stop loss is triggered, you will lose 3,000 rubles, which fully fits into the accepted risk parameters. Even if your trading day turns out to be so unfortunate that your stops work three times in a row, you will lose 3 × 3000 = 9000 rubles, which also fits into the established amount of daily risk (10 000 rubles).

Let me remind you that in such an unsuccessful scenario, I recommend that you stop further trading on this day and begin to find out the reasons for the failed transactions.

As you can see, we still have not resorted to higher mathematics formulas, which means that there is nothing complicated in the calculations related to risk management.

Now let's recall that the size of the technical stop can be either larger or smaller than the calculated one. What do we do in this case in order to comply with key risk parameters?

Earlier, we have already said that you need to correctly assess the strength of price levels and look for the possibility of setting a shorter stop, turning the mathematical expectation in your favor. You already know that a shorter stop allows you to do with a smaller power reserve to ensure the necessary ratio of profit to risk. Now let's look at the same situation from the point of view of money management. And so that you do not have to take my word for it, we turn again to the numbers.

Let's say that on the chart of all the same Gazprom stocks you have identified such a strong level that it allows you to get by with a stop half the standard. We apply once again the above calculation scheme and calculate the potential profit of the same transaction. You bought 1000 lots of Gazprom at a price of 150 rubles. and set the stop to half the standard (0.15 rubles. instead of 0.30 rubles.). The market went in your direction, and you earned profit in an amount equal to three stops: 3 × 0.15 = 0.45 rubles. per share. Profit for the whole position volume: 0.45 rubles. × 10,000 shares = 4,500 rubles.

It would seem that it is not bad and fully consistent with the target ratio of profit to risk. But let's see what knowledge of the principles of money management can give us in this situation.

The amount of monetary risk per deal remained unchanged - 3,000 rubles, but taking into account halving the size of the stop, the position that we can afford without violating risk parameters will be already: 3,000 rubles / 0.15 rubles. = 20,000 shares = 2,000 lots. Then, with the same market movement in our direction, we will receive a profit equal to: 0.45 rubles. × 20,000 shares = 9,000 rubles. This is twice as much, and note, at the previous risk level! Indeed, in the event of failure, we lose the same 3,000 rubles, but the size of the potential profit doubles. This is why we need knowledge of the principles of money management.

Naturally, in those cases when the technical stop turns out to be larger than the calculated one, it will be necessary using the same calculations not to increase, but to reduce the size of the trading position.

Thus, having correctly fixed the key parameters of acceptable risk, you can optimize your trading in such a way as to minimize possible losses and at the same time maximize potential profit.

In conclusion, a few words about the recommended approach to increasing trading volumes. Such a need will necessarily arise when you start to make a profit. But no matter what market you trade in, my advice is: do not increase the risks after the first successful month. Statistical indicators of your profitability can be as volatile as the market itself. Do not double your bets. Increase your trading volume gradually, leaving a margin for a possible rollback.

If you trade futures, start with one contract [12] to make sure that your trading algorithm works successfully. Closing a week with a profit, add one contract to the volume. After your trading volume reaches five contracts, start adding (if successful) already two or three contracts, but, of course, taking into account the size of your deposit and without violating key risk parameters.

If a trading week ends with a loss for you, on the contrary, reduce the number of traded contracts according to the same ladder principle.

Remember: it is better to grow gradually, but surely, than quickly, but at the risk of losing everything in one day.