Money Management Strategies for Serious Traders

Trading is surely a numbers game and money management is the most important component of a trading plan. It will determine how much you make, and applying the right one will make the difference between single-digit returns and making the kind of money you deserve. In this article, I’m going to introduce you to 5 money management strategies that you can start using to reach your goals.

Money Management Strategies for Serious Traders

1. The 2% Rule: Uses a percentage of your capital for each trade.
2. Fixed Fractional: Trades 1 contract for every X amount of dollars.
3. Fixed Ratio: Sets a delta to determine when to increase or decrease the position size.

What is Money Management?

Money management is a strategy for increasing or decreasing the position size to limit risk while achieving the greatest growth possible from a trading account. There are good and bad ways of implementing money management, and the right way focuses on both the risk and reward factors on your account. It allows you to leverage the account while balancing risk. Money management can be used when trading any market as it is focused on one thing alone, and that is account performance.

Martingale vs. Anti-Martingale Strategies

There are 2 basic approaches to money management, martingale, and anti-martingale. Martingale methods increase the position size with losses. As the account is in a losing streak the trader will double the position size in order to re-coop all the losses and make a little profit.

Anti-martingale methods are the opposite. The position size increases with wins and decreases with losses.

Martingale Methods

The idea is that a losing streak won’t last forever and once it ends the account will be profitable. However, in reality, losing streaks can go on and on and on, and the trader will be risking everything just to get back to breakeven. Psychologically, it is almost impossible to implement. Martingale methods create geometric risk, not growth. Are you really going to risk blowing out your account on one trade just to make up for all the losses and make a small profit?

Anti-Martingale Methods

Anti-martingale methods increase the position size with wins. This is the type of money management that should be used by traders. When there is a drawdown and there most definitely will be, anti-martingale methods won’t bring the account profitable on 1 trade, but they will control the risk creating a much smaller drawdown, making it much easier to recover. All the money management strategies presented below are anti-martingale methods.

What type of trader are you?

Before you decide on the best money management strategy for you, it’s important to ask yourself what type of trader you are. Everyone is different and there is no one with the same personality as you. Trading is a very psychological endeavor and as such you need to implement an approach that best fits your personality.

Are you a conservative trader that wants lower risk and stable returns? Or are you an aggressive trader willing to accept higher risk for geometric growth? Depending on your trading personality you can choose a money management approach that fits your style of trading.

The bottom line is, the greater the risk, the greater the potential return.

Fund Management vs. Independent Trading

Fund Managers focus on risk and the amount of money under management, not profit. This may sound counter-intuitive but look at the fees funds charge and it will be clear. Funds take a percentage of the profits made and a percentage of the money in the fund. Since they have many investors, the best way to keep them happy and in the fund is to beat benchmark returns of say the S&P 500. They achieve this by keeping risk low, below say 15%.

Independent traders focus on making money. As they are managing much less capital than a typical fund, they need to make the money work harder in order to achieve their goals from trading. Not having the psychological stress that comes with managing other people’s money, they are willing to accept higher risks in the 30-50% range with the potential to make 100-300%.

Small traders who approach money management like a fund manager are usually disappointed when their results and goals don’t match up. The right money management will help you achieve your goals and make trading worthwhile.

What Money Management is NOT

Money management is NOT risk management.

Money management is NOT position sizing. 

Risk Management addresses the amount of risk you will take on a given trade. Position Sizing addresses the size of the position you will use for the trade. These are ways of implementing money management. Money management will determine whether or not the size should be increasing or decreasing.

Money management is NOT going to turn a bad trader into a good one. It cannot turn a bad strategy into a winning one. If a trader doesn’t have the disciplines required to trade correctly then money management will not work.

Money management will provide geometric growth to your account when correctly trading a strategy with a positive expectancy. A positive expectancy simply means that when you average out all the wins and losses that you make money, you have an edge.

Why is money management important?

Money management is important because it will give you a strict path to follow in order to reach your goals as a trader. If you are too aggressive as a trader, then you will make a lot when you are right but you run the risk of catastrophic loss. If you are too conservative, then you won’t cover the costs of trading or achieve your goals.

The goal as an independent trader should be to make as much money as possible while making sure you don’t blow out your account.

1. The 2% Rule Method

The 2% Rule is an anti-martingale money management method that is based on your account size.

Risk per Trade = Account Balance X 2%

To apply the 2% rule, you can use a position size calculator that is very easy to use that will spit out your position size for each trade with just a few clicks.

This is a conservative approach that focuses on limiting risk and is a good method if you are a new trader just starting out. It will keep you in the game while you build your confidence and valuable experience.

It is also a good method for accounts over $1 million. Larger accounts don’t need to risk as much to achieve acceptable returns.

However, It is not really growth-orientated and difficult to use in some leveraged markets. Traders starting with smaller accounts are willing to accept more risk in order to make more money.

2. Fixed Fractional Method

One fixed fractional method commonly used is to trade 1 contract for each X amount of dollars in the account. X can be set to be a large or small number.

X = $10,000; If Account Balance = $20,000, then Position Size = 2 contract

To apply this method you would begin trading 1 contract, and once your account reached $30,000, then you increase your position size to 2 contracts, and so on.

When X is too large then this method is risk-averse but growth is slow. When X is too small then growth is quick but there is a possibility of catastrophic loss.

3. Fixed Ratio Method

The Fixed Ratio Money Management Method was developed by Ryan Jones and presented in “The Trading Game”. It is a very different approach to money management.

Fixed Ratio focuses on profits made rather than the size of the account. There is just one variable called the “Delta”.

Delta = $1,000; Position size increases when $1,000 per contract in profits are made.

The delta is determined by the max drawdown of your trading plan. If your strategy produces large drawdowns, he recommends a delta of 1/2 the max drawdown and equal to or greater than the max drawdown for low drawdown strategies.

As long as you have enough capital in your account to cover risk, margin, and some breathing room, it doesn’t matter whether you have $10,000 in your account or $100,000, the size of your account is not a factor.

Begin trading with 1 contract and once you’ve made $1,000 in profits, increase the position size to 2 contracts. Since you increase the position size with every $1,000 made PER contract, increase the position to 3 contracts once you’ve made $2,000 in profits.

This method is great for smaller accounts. The risk on the account peaks at the 4-5 contract level and continually decreases as the account grows. It isn’t optimum for larger accounts of over $1 million, but it is a method that will get you there most efficiently. It provides geometric growth without the catastrophic risk!

“Even a poor trading system could make money with good money management.” - JACK D. SCHWAGER