Money Management 2

Define Risk

There are two kinds of risk level to determine before going ahead with money management framework- i) monetary risk and ii) technical risk.

Monetary risk
It is simply the dollar amount willing to risk for each trade. Usually it is a percentage of the account size e.g, 1%, 2% or 3% etc.

Technical risk
It is a price level at which the position will be closed, usually in a loss. It can either be fixed ( e.g, support/resistance line) or dynamic ( e.g, trend following with moving average).

Monetary risk + technical risk = position sizing

So far, it is easy to calculate position size for a given set up. In the past, I used to end up here thinking that my trading plan was complete. I know my risk, TA stoploss is there and position sizing is perfect! But there is a much bigger thing to consider.

Money Management

What is the most important thing in money management?
It is to produce positive expectancy.

How do we achieve that?
Easy, profits must be greater than losses for one of the followings

i) a set time interval .. daily, weekly or monthly etc, or
ii) a set number of trades.

That requires historic performance or projected performance. Win:loss money value ratio and winning trade % are required to calculate expectancy of a method.

When a new method or system is launched, there is no reliable performance data to be used as a benchmark. Backtesting can be done, but it is too idealistic as it lacks human factor in the equation. Therefore, the money management frameworks tends to be geared towards ideal situation and a trader may find it hard to copy that in real live trading.

The irony is that without no reliable performance data, money management framework can't be formulated. It's like a bit of chicken and egg situation. So how do we do that?