kooole

Money management is a critical point that shows difference between winners and losers. It was proved that if 100 traders start trading using a system with 60% winning odds, only 5 traders will be in profit at the end of the year. In spite of the 60% winning odds 95% of traders will lose because of their poor money management. Money management is the most significant part of any trading system. Most of traders don't understand how important it is.

It's important to understand the concept of money management and understand the difference between it and trading decisions. Money management represents the amount of money you are going to put on one trade and the risk your going to accept for this trade.

There are different money management strategies. They all aim at preserving your balance from high risk exposure.

First of all, you should understand the following term Core equity
Core equity = Starting balance - Amount in open positions.

If you have a balance of 10,000$ and you enter a trade with 1,000$ then your core equity is 9,000$. If you enter another 1,000$ trade,your core equity will be 8,000$

It's important to understand what's meant by core equity since your money management will depend on this equity.

We will explain here one model of money management that has proved high anual return and limited risk. The standard account that we will be discussing is 100,000$ account with 20:1 leverage . Anyway,you can adapt this strategy to fit smaller or bigger trading accounts.

Money management strategy

Your risk per a trade should never exceed 3% per trade. It's better to adjust your risk to 1% or 2%
We prefer a risk of 1% but if you are confident in your trading system then you can lever your risk up to 3%

1% risk of a 100,000$ account = 1,000$

You should adjust your stop loss so that you never lose more than 1,000$ per a single trade.

If you are a short term trader and you place your stop loss 50 pips below/above your entry point .
50 pips = 1,000$
1 pips = 20$

The size of your trade should be adjusted so that you risk 20$/pip. With 20:1 leverage,your trade size will be 200,000$

If the trade is stopped, you will lose 1,000$ which is 1% of your balance.

This trade will require 10,000$ = 10% of your balance.

If you are a long term trader and you place your stop loss 200 pips below/above your entry point.
200 pips = 1,000$
1 pip = 5$

The size of your trade should be adjusted so that you risk 5$/pip. With 20:1 leverage, your trade size will be 50,000$

If the trade is stopped, you will lose 1,000$ which is 1% of your balance.

This trade will require 2,500$ = 2.5% of your balance.

This's just an example. Your trading balance and leverage provided by your broker may differ from this formula. The most important is to stick to the 1% risk rule. Never risk too much in one trade. It's a fatal mistake when a trader lose 2 or 3 trades in a row, then he will be confident that his next trade will be winning and he may add more money to this trade. This's how you can blow up your account in a short time! A disciplined trader should never let his emotions and greed control his decisions.

Diversification

Trading one currnecy pair will generate few entry signals. It would be better to diversify your trades between several currencies. If you have 100,000$ balance and you have open position with 10,000$ then your core equity is 90,000$. If you want to enter a second position then you should calculate 1% risk of your core equity not of your starting balance!. Itmeans that the second trade risk should never be more than 900$. If you want to enter a 3rd position and your core equity is 80,000$ then the risk per 3rd trade should not exceed 800$

It's important that you diversify your prders between currencies that have low correlation.

For example, If you have long EUR/USD then you shouldn't long GBP/USD since they have high correlation. If you have long EUR/USD and GBP/USD positions and risking 3% per trade then your risk is 6% since the trades will tend to end in same direction.

If you want to trade both EUR/USD and GBP/USD and your standard position size from your money management is 10,000$ (1% risk rule) then you can trade 5,000$ EUR/USD and 5,000$ GBP/USD. In this way,you will be risking 0.5% on each position.

The Martingale and anti-martingale strategy

It's very important to understand these 2 strategies.

-Martingale rule = increasing your risk when losing !

This's a startegy adopted by gamblers which claims that you should increase the size of you trades when losing. It's applied in gambling in the following way Bet 10$,if you lose bet 20$,if you lose bet 40$,if you lose bet 80$,if you lose bet 160$..etc

This strategy assumes that after 4 or 5 losing trades,your chance to win is bigger so you should add more money to recover your loss! The truth is that the odds are same in spite of your previous loss! If you have 5 losses in a row ,still your odds for 6th bet 50:50! The same fatal mistake can be made by some novice traders. For example,if a trader started with a abalance of 10,000$ and after 4 losing trades (each is 1,000$) his balance is 6000$. The trader will think that he has higher chances of winning the 5th trade then he will increase ths size of his position 4 times to recover his loss. If he lose,his balance will be 2,000$!! He will never recover from 2,000$ to his startiing balance 10,000$. A disciplined trader should never use such gambling method unless he wants to lose his money in a short time.

-Anti-martingale rule = increase your risk when winning& decrease your risk when losing

It means that the trader should adjust the size of his positions according to his new gains or losses.
Example: Trader A starts with a balance of 10,000$. His standard trade size is 1,000$
After 6 months,his balance is 15,000$. He should adjust his trade size to 1,500$

Trader B starts with 10,000$.His standard trade size is 1,000$
After 6 months his balance is 8,000$. He should adjust his trade size to 800$

High return strategy

This strategy is for traders looking for higher return and still preserving their starting balance.

According to your money management rules,you should be risking 1% of you balance. If you start with 10,000$ and your trade size is 1,000$ (Risk 1%) After 1 year,your balance is 15,000$. Now you have your initial balance + 5,000$ profit. You can increase your potential profit by risking more from this profit while restricting your initial balance risk to 1%. For example,you can calcualte your trade in the following pattern:

1% risk 10,000$ (initial balance)+ 5% of 5,000$ (profit)

In this way,you will have more potential for higher returns and on the same time you are still risking 1% of your initial deposit.

~~Written by Fxmaster.net~~

The Art Of Surviving Through Money Management

Reprint of article appearing in Futures magazine, July 1981 By Walter Bressert

For many commodity traders, the futures markets are a game of balancing fear, greed and hope. When a trader is out of balance, he likely will lose money, and if he is out of control, he will lose balance. Well-designed money management concepts can help to keep the trader in control at all times.
Trading Commodities involves three interrelated, yet somewhat separate operations:

1. Analysis of when and at what price level a market will top and bottom. 2. Market Entry and Exit – the actual buying and selling (or trading) once the decision has been made. 3. Money Management, perhaps most aptly called the art of survival. Most futures traders spend 99% of their time on analysis and the buying and selling of markets. Many of these traders ultimately join the legions of ex-futures traders because they ignored the most important aspect of speculation – money management.
You can be a good analyst and lose money trading due to poor money management. But, if you have sound, market-proven money management concepts, and the discipline to follow them, you will never lose all of your money.
Since developing the following money management concepts in the mid-70s, I’ve had large profits as well as large losses – but never a single margin call. There is no guarantee that you will make money using these money management rules, but you will never lose the farm.
Before entering the market, determine a stop/loss as a profit objective. Many traders often enter the market with a price objective, but without a clearly defined protective stop. When the market moves against them they are often forced out of the size of their margin call. They lose control, and the results are often disastrous. What should have been a relatively small loss becomes an extremely large loss.
With a pre-determined price objective and a pre-determined stop/loss, you know where you will get out if you are wrong and where you will get out if you are right. You have control. The stop/loss must be in the market, not in your mind.
If you have been stopped out only to have the market make the move without you, the problem was how you determined where to place your stop, not whether to use stops.
Never risk more than 10% of equity on any single trade. If possible, risk 5% or less. Never risk more than 20% in any one complex.
If you are like most traders, you always figure how much you could make. The question of how much you could lose if you are wrong is never quantified. You are out of control.
The most important question in trading leveraged markets is – How much of your equity is at risk? On any given day, for any given trade you must know how much you will lose if the market goes against you. You can maintain control by never risking more than 10% in any one trade, and by adjusting stops so you are never risking more than a maximum of 20% of open equity at any time.
In reality, the 20% risk factor should exist for only a few days at most, as explained in the following multiple contract approach which will greatly reduce your exposure within several days of entering the market.
Trade multiple contracts
One of the most important concepts is to trade in multiples of three. Whether two, three, ten or a hundred contracts are traded, most traders make the mistake of entering and exiting all contracts at the same price level. They are going to be all right or all wrong. In using multiple contracts, no fewer than three contracts should be traded per position, and one-third of each position should have a different profit objective. If trading three contracts, each contract would have a different price objective; if trading 90 contracts, each grouping of 30 contracts would have a different price objective. With each 1/3rd of a position having a different price objective you can be wrong on your expectations and still make money!
For example, a $30,000 account risking 10% of equity can afford to risk $3,000 on the overall position. If the dollar risk per contract from point of entry to stop/loss is $900, commissions and skiddage might equal another $100; the dollar risk per contract is $1,000 with a total $3000 for the three contracts in the position.
Contract No. 1: The Money Contract
The first contract, called the Money Contract, is the most important. When possible, the profit figure for the Money Contract should equal the dollar risk, but should seldom be more than $1,000 under normal market conditions. In our example, the pre-determined dollar risk per contract, including skiddage is $1,000, so our pre-determined profit objective for the Money Contract is also $1,000.
It is important to have all three contracts on before the market moves. All three contracts can be entered at once, or can be put on at different price levels. Once the three contracts are positioned, place an exit order for the money position at the pre-determined profit objective. This order should be placed every day before the open.
Profits on the money contract should be taken as quickly as possible. Normally, the money contract should be liquidated within five market days. If not, you may be expecting too much from the market you are trading, or the market may be telling you that it is not going to move in your direction.
When the money contract is liquidated, the whole tone of the market changes because, now your risk is lowered by two-thirds of your initial risk exposure, and best of all, you have $1000 in closed profits in your account.

2:In our example of a $30,000 account risking 10%, a three-contract position was entered at $1,000 risking 10%, or 3 1/3% risk per contract. Once profits have been taken on the Money Contract, not only has its 3 1/3% risk for the Number 2 Short-Term Contract, dropping the total dollar risk to about 3 1/3% for the two remaining positions – your emotional commitment is similarly reduced.
CONTROLLED RISK MONEY MANAGEMENT

30,000 X 10% = 3,000 $Risk %Risk No. 1 Money Contract 1,000 3 1/3 No. 2 Trading Contract 1,000 3 1/3 No. 3 Long Term Contract 1,000 3 1/3
Take profits on
Exit No.2 Contract with $1000 profit. T.C. Bottom Buy 3 Contracts Exit No.1 Contract with $1,000 Profit T.C. Bottom Buy 3 Contracts T.C. Bottom Fails to retrace enough to add 3 contracts. Take profits on No.1 Contract as T.C. price objective is met. Take profits on No. 2 Contract as T.C. price objective is met. No.3 Contract as T.C. price objective is met. Contract No. 2: The Short-Term Profit Objective Contract
The Short-Term Contract is also designed to take profits at a pre-determined profit objective. Normally, this can be the crest of a Trading cycle in a bull market, or the Trading Cycle trough in a bear market. Either get out at this price objective, or as prices approach your price objective, move stops closer and have the market take you out.
In our $30,000 account, if you make $2,000 on the Short-Term Contract, you now have $3,000 in closed profits and a third position that has a $2,000 open profit.
Contract No. 3: The Long-Term Profit Objective Contract
The purpose of the Long-Term Contract is to keep you in the market for the BIG moves. Assuming you liquidated the Short-Term Contract near the Trading Cycle top, the Long-Term Contract will give up some profit as the Trading Cycle bottoms. But, the purpose of the Long-Term Contract is to comfortably ride with the market until your long-term price objective is reached, which is often the price objective for the Primary Cycle or the Seasonal Cycle.
These money management concepts can be modified depending upon the position of the Trading Cycle and when the buy/sell signal is generated.

3 :Shown in the following example is the first three-contract position, which is entered at the Trading Cycle bottom with a dollar risk of about $1,000 per contract (point of entry to the Trading Cycle low, which is the stop, plus commissions and expected skiddage).
Within several days of entry, the No. 1 Money Contract should be liquidated with $1,000 profit. As the Trading Cycle moves up, a $1000 profit is taken on the No. 2 Short-Term Profit Objective is met. The No. 3 Contract is held through the Trading Cycle bottom in anticipation of reaching the higher Primary Cycle or Seasonal Cycle price objective.
As the Trading Cycle bottoms, three more contracts are bought for a total of four contracts – two Long-Term Contracts, the Money Contract and the Short-Term Profit Objective Contract. As the market moves up, the money contract is liquidated at the pre-determined price objective and a short-term profit is taken as the Trading Cycle tops. Both Long-Term Contracts are held expecting higher prices as the long-term objective is met.
As the next Trading Cycle bottoms in this example, the market does not retrace as expected; so new contracts are not added. The market takes off without the additional three contracts, but leaves two Long-Term Contracts that can be liquidated at two different price levels as the Primary Cycle tops. Should the market fail to reach the long-term price objective, technically determined fail-safe stops must be maintained for the two remaining Long-Term Contracts. But, assuming all goes well, each of the two Long-Term Contracts can be liquidated at different price levels as the long-term objective is met. (My own approach is to take one-half of the profits on strength before the market tops.)

Some Pratical Thoughts Abaut Money Management

Forex Money Management | Written by Chuck LeBeau |

We get a lot of questions about various complex money management (MM) formulas and our preferences. We don't comment on this subject very often because money management is such a personal issue that it would be impossible to give any universal advice that would be specific enough to have value. Everyone seems to have different goals and tolerances for risk, not to mention varying amounts of capital for trading.

However we do have some basic thoughts and opinions that might be helpful in picking a suitable MM strategy that will help you to become a winner.

Be careful about trying to use formulas that are designed to optimize the returns. In my experience I have found that the most successful traders, over the long run, are not seeking to maximize their returns. The best traders are always seeking to carefully control their risks and to achieve as much consistency as possible. They look for methods to achieve consistent returns with low drawdowns and they are willing to accept smaller returns in the process. My policy has always been to worry about the risk and the consistency first and then to accept whatever returns that prudent approach will allow. I'm sure I will never win any trading contests and I have never bothered to enter one. In my opinion, no one should ever trade like the winner of a trading contest. I apologize for getting off on a different subject here. Lets get back on track and talk about trading in the only contest that matters - the trading that you do every day.

In recent years the strategy of risking a small percentage of capital on each trade has become quite popular and deservedly so. This MM strategy, often referred to as fixed fractional trading, reduces our dollar amount of risk as we experience losses and increases our risk level as we earn profits. The possibility of ever going to zero with such a strategy is virtually nonexistent. However this strategy has an inherent weakness that tends to constantly work against us. If we assume an equal number of winners or losers in a sequence this popular strategy produces net losses if the winners are not larger than the losers. To keep things very simple lets just look at a series of five wins followed by five losses with the wins being equal to the amount we risk. Lets also keep the math really simple and begin with starting capital of 100 and risk 5% of our current capital on each trade. I think that most traders would assume that if they had five losers followed by five winners they would be even. Unfortunately that is not the case.

Here are the numbers: Risk is always 5% of current capital. (I'm going to round the numbers to two decimals.)

Capital $ Risk W/L Account balance
100.0 5.00 L 95.00
95.00 4.75 L 90.25
90.25 4.51 L 85.74
85.74 4.29 L 81.45
81.45 4.07 L 77.38

OK we are already tired of losing. Let's have five winners in a row and see if we can get our money back.

Capital $ Risk W/L Account balance
77.38 3.87 W 81.25
81.25 4.06 W 85.31
85.31 4.27 W 89.58
89.58 4.48 W 94.06
94.06 4.70 W 98.76

As you can see we had an equal number of winners and losers yet somehow we lost money. Perhaps it is because we had bad luck and got started in the wrong direction. Lets reverse the sequence of trades so that we start out on a winning streak instead of losing. Maybe that will help.

Capital $ Risk W/L Account balance
100.00 5.00 W 105.00
105.00 5.25 W 110.25
110.25 5.51 W 115.76
115.76 5.79 W 121.55
121.55 6.08 W 127.63

Looks good so far. Starting off with winners looks much better than starting with losses. But now we have five losers coming up.

Capital $ Risk W/L Account balance
127.63 6.38 L 121.25
121.25 6.06 L 115.19
115.19 5.76 L 109.43
109.43 5.47 L 103.96
103.96 5.20 L 98.76

Hmmm. It doesn't seem to matter if we start out with a string of winners or a string of losses. Somehow we wound up losing the same amount of money either way.

Obviously we don't have a very good system at work here but it is not a losing system. With the proper MM strategy we should break even. Our winning trades are only equal to our risk and to have a winning system the winners need to be bigger than the losers. We are winning on only half of our trades and we would be profitable if we could win on more than half. Even though our system is not a good one you would think that it would at least be a breakeven proposition (we haven't included any costs) because the winners are always equal to the amount at risk and we win 50% of the time. That sounds like a breakeven system, doesn't it? But if we employ the popular money management strategy of risking a fixed percentage of our current capital we manage to turn the system into a loser. However, if we risked a fixed dollar amount on each trade the system results would improve and we would break even.

The fixed percentage of risk approach to MM is a good one because it keeps us from going broke and it compounds our profits rapidly. Both of those are desirable characteristics but we need to be aware that they come at a price. We should realize that our recovery from drawdowns might not be as fast as we would like and that we can give back profits even faster than we made them.

One strategy that can help solve the problem of giving back the profits too rapidly is to periodically sweep some of the profits out of the account and place them in some other place where they are adding to our diversification and reducing our risk. Now and then we should take some of the profits out and spend them on something that improves our quality of life. This important step gives the dollars at stake a new meaning and boosts our morale tremendously. What is the point of winning and losing and accumulating profits only to give them back at some later date? If we make it a practice to routinely sweep some of the profits our account will continue to grow but it will be compounding at a slower rate than if we left our profits at risk. However if we stumble into a losing streak we will be glad that we took out some of the profits and reduced our bet size.

If we are good traders and we make it a practice to withdraw some of our profits on a regular basis we will eventually reach the point where we have taken out more than we started with. There are very few traders, particularly in futures, who can claim that they have truly beaten the market. Until you have taken out more than you started with the market can still beat you. Trading futures is a zero sum game and winners are few and far between. Taking out profits now and then rather than getting carried away trying to optimize the gains to infinity is contrary to what is being taught these days. Everyone is obsessed with finding formulas to optimize the returns. We need to remember that the trader who has the optimum gains today could easily be tomorrow's biggest loser. That is a game we don't need to play.

I think we all need to take a step or two back and look at the big picture. Trading is not really just a game. The money is real. Lets make sure that we are true winners and not just habitual players. Take some profits now and then and put them out of harms way. When we have done this I can assure you that the game is a lot more fun and our trading will improve. Nothing builds confidence like knowing for sure that you are indeed a winner.

Good Luck and Good Trading

Traderclub
~~by Chuck LeBeau~~
Money Management

~~by Joe Ross~~

There are some common mistakes I’ve seen traders make in the area of money management. First, let’s understand what money management is all about. Money management overlaps with risk, trade, business, and personal management, yet it has many aspects that make it unique, distinctly different from all of the other areas of management. In this chapter we want to examine some areas of money management that seem to involve mental quirks leading to costly mistakes.

Listening to Opinion

Kim has entered a short position in crude oil after carefully studying as many factors as she could reasonably include while making her decision to trade. She has entered the trade because her study of the underlying fundamentals has her convinced that crude oil prices must soon begin to fall. Then Kim turns on her television set and begins to watch one of the financial news stations. An “expert” in crude oil is being interviewed. He begins to talk about how crude oil inventories are almost certain to drop this year because oil companies are not doing as much exploration as they have in previous years. Kim listens intently to what he has to say and then begins to doubt her decision about the trade she has entered. The more she thinks about it, the more panicky she becomes. She considers abandoning her position even though she will end up with a loss.

The fact that an “expert” has decided something else completely shakes her confidence. She exits the trade intraday and takes a $400 loss. Prices have not come near her protective stop, which was $700 away from her entry. The market never moves sufficiently far to have taken out her stop. By the end of the day, her crude oil futures have made a new high, and in the following days explodes into a genuine bull market. Instead of a magnificent win, Kim has a loss. The loss is more than money, she has lost confidence in herself.

What should be done?

You should set your own trading guidelines and trade what you see. Forget about opinion, your own and especially that of others. Unless you are one of a very rare breed whose opinions are sufficiently good for trading, do not trade on them.

Make an evaluation based on the facts you have and then go with the trade. Just be sure you have a strategy for extricating yourself before losses become big. Had Kim stayed with her original strategy and stop placement, she would have ended up a happy winner instead of a regretful loser.

Taking Too Big a Bite

Biting off more than can be chewed is a weakness of many traders. This form of over trading derives from greed and failing to have clearly defined trading objectives. Trading only to “make money” is not sufficient.

Pete has sold short T-Bonds and is now ahead by a full point. He notes that he is making money on his trade. Feeling very confident and thinking it would be smart to be diversified, he enters a long position in silver futures, and also sells short Call options of wheat which he is sure is headed down. Almost as soon he is in the market, wheat prices explode upward and his Calls are in trouble. Pete buys back the losing short Calls and sells additional Calls on a two-for-one basis at a higher strike price. At the end of the day he looks at other positions. Silver had an intraday reversal leaving a spiked bottom as they close at the high of the day. The T-Bonds have made an inside day, but to Pete they suddenly look weak, he is down a few ticks. At the end of the day, he finds that most of the money he had made on his short T-Bonds was used to buy back the short wheat Call options. He covered those and now has additional premium in his account, but he also has additional risk, and is short Calls in a rising market – not an enviable position. Moreover, he is now worried about his long silver futures based on the fact that silver closed at its lows on what seems to be a genuine reversal. To further aggravate the situation, he has lost confidence in himself. What was once a happy, simple, winning silver long, has now become an ugly, confusing mess, and Pete has a good chance of ending up a loser on all three trades. If Pete keeps over-trading in this fashion, he could end up like the poor fellow in the picture.

What should be done ?

Break every trade into definitive goals. Make sure you achieve those goals before adding other positions. Even with a single short sale of the T-Bonds, Pete could have set himself a goal for the trade. One or two full points might have been all he needed to satisfactorily retire that trade as a winner. Then he could have made his trading decision for an additional position. There are very few traders who can successfully manage multiple positions in a variety of markets.

Overconfidence

Overconfidence is a particular kind of trap that springs shut when people have or think they have special information or personal experience, no matter how limited. That's why small traders get hurt trading on no more information than “hot-tips.”

Tim is a farmer. He raises hogs and purchases huge amounts of feed to provide for his hogs. Tim has a large farming operation which is quite profitable. He takes 250 hogs a week to market. Because of a steady flow of hogs from his operation to the market, Tim has no need to hedge his hog business because he is able to dollar average the prices he gets for them. But Tim does want to indirectly reduce the cost of the feed he has to buy, so he purchases soy meal futures. Tim listens to weather and farm reports all day long. He attends meetings of other farmers, and tries to gather all the information he can that might help him be more profitable. But Tim has a major problem, called tunnel vision. When he looks out at the grain fields in the area where he lives, whatever he sees there he extrapolates to the whole world.

In other words, if Tim sees that the surrounding fields are dry, he suspects that all fields everywhere must also be dry. One year Tim witnessed a local drought. He checked with all the local farmers and they said they were truly experiencing drought conditions. He looked at the news on his data feed, and sure enough it said that there was a drought in his area. In fact, the entire state where Tim raises his hogs was undergoing drought.

Tim wasn’t too concerned about his own feed bins. He had plenty of it in his silos from previous bumper crop years. Tim decided to be piggish and speculate on what he considered to be inside information. He called his broker and bought heavily into soy meal futures. Tim was confident. He was sure that soy meal prices would explode upward some time soon, and that he was going to make himself a small fortune. Tim's greed may have turned him into a hog. However, the futures he purchased started moving down and the value of his investment began to shrink markedly. What Tim failed to do was to have a broader perspective. Everywhere else that grains were grown, farmers were experiencing rain in due season. The drought was localized almost entirely within the state in which Tim did his hog raising. Tim lost because he was confident in the limited knowledge he had.

What should be done?

We all need to broaden our horizons. We need a humble attitude relative to the markets. We can never afford to wallow in overconfidence in what we perceive as special knowledge. A trader can never afford to let his guard down. Tim thought he knew something that others hadn’t yet caught onto. In so doing, Tim made another mistake as well. He heard only what he wanted to hear.

Hearing What You Want to Hear – Seeing What You Want to See

Marketers call this preferential bias. Preferential bias exists among traders. Once they develop a preference for a trade, they often distort additional information to support their view. This is why an otherwise conscientious trader may choose to ignore what the market is really doing. We've seen traders convince themselves that a market was going up when, in fact, it was in an established downtrend. We’ve seen traders poll their friends and brokers until they obtained an opinion that agreed with their own, and then enter a trade based upon that opinion.

A student of ours, Fran and her husband, John, decided they wanted to go to live in the Missouri Ozarks. Everyone told them that there was no way for them to make a living there.

Everyone they asked advised them not to do it.

Finally, a minister in the Church they proposed to attend told them that they were to serve there. Out of twenty or thirty people they asked, that minister was the only one who told them to come. Of course, it was exactly what they wanted to hear. They sold their home and most of their possessions accumulated over a lifetime. They moved to the Ozarks and went broke within a year. They had to leave and begin all over again. John, who had been semi-retired, now had to find a job. So did Fran. She had to give up a promising start as a trader to go out to put food on the table.

What should be done?

Look at each trade objectively. Do not allow yourself to become married to your opinion. Learn to recognize the difference between what you see, what you feel, and what you think. Then, throw out what you think. Lock out the input of others once you have made up your mind. Don't let your broker tell you what you want to hear. Never ask your broker, your friends, or your relatives for an opinion. Turn off your TV or radio, you don't need to see or hear what they have to say. Take all indicators off your chart and just look at the price bars. If you still see a trade there, then go for it.

Fearing Losses

There is a huge difference between being risk averse and fearing losses. You must hate to lose. In fact, you can program your brain to find ways to not lose. But not losing is a logical thought-out process, rather than an emotion-based reaction.

Two human -based tendencies come into play. The first is the sunk-cost fallacy and the second is the exaggerated-loss syndrome.

Sunk-cost fallacy: You are in a trade that begins to go against you. You reason that you have already spent a commission, so you have costs to make up for. Moreover, you have spent time and effort researching and planning this trade. You reckon that time and effort as cost. You have waited for just such an opportunity and you are afraid that now that it has come you will have to miss this trade. The time spent waiting for opportunity is something you also count as cost. You don't want to waste all these costs, so you decide to give the trade a little more room. By the time you realize what you’ve done, the pain is almost overwhelming. Finally, you have to take your loss which is now much larger than it might have been. The size of the loss adds to your fear of ever losing again. The end result is brain lock and inability to pull the trigger on a trade.

Exaggerated-loss syndrome: You give the importance of losing on a trade two to three times the weight of winning on a trade. In your mind, losses have greater significance than wins. In reality, neither is more or less important than the other. In fact, wins do not have to be as numerous as losses as long as the wins are significantly larger in size than the losses. Of course, best is to have more wins than losses with the wins greater in size than the losses.

What should be done?

Evaluate your trades solely on their potential for future loss or gain. Ask yourself, “what do I stand to gain from this trade, and what do I stand to lose from this trade?” Think the matter through. “What is the worst thing that can happen to me if I take this trade, and do I have a plan and a strategy for extricating myself long before it happens?” “If I begin to lose, is there a way I can turn things around and come out a winner?” Learn to look at the costs of a trade as part of your business overhead. Try to have a mind set that you will not throw good money after bad. When you give a trade more room, you are doing just that – often throwing away money.

Valuing invested money More Than won money

Traders have a tendency to be more careless with money they’ve won than with money they’ve invested. Just because you won money on good trades doesn’t mean you should gamble with that money. People are more willing to take chances with money they perceive as winnings as though it were found money. They forget that money is money. Valuing money depending on where it comes from can lead to unfortunate consequences for a trader. The tendency to take greater risk with money made from trades than with money invested as capital makes no sense. Yet traders will take risks with money won in the markets that they would never dream about with money from their savings account.

What should be done?

Wait awhile before placing at risk money won on trades. Keep your trading account at a constant level. Strip your winnings from your account and put them in a safe conservative place. The longer you hold on to money, the more likely you are to consider it your own.

Forgetting About Margin Inflation

Before the crash of 1987, S&P 500 stock index futures carried an exchange minimum margin of about $12,000 . Immediately after the crash, margins required by some brokers rose to $36,000 and higher.

A trader we know, called Willie, figured that if prices on an index he was short went down, he would continually add to his position whenever prices first pulled back and then broke out to new lows. The index he was trading became very volatile, and his broker raised margins to by 1/3 rd. Willie was trading a small account, and when he tried to sell short additional contracts onto his already short position, his broker would not allow him to do so. Willie complained bitterly, but the broker was adamant in his refusal. The broker would not allow Willie to use unrealized paper profits to cover the additional margin required for adding on. He explained to Willie that to do so would in effect allow Willie to build a pyramid position and that was not going to be allowed by the broker's firm.

The mistake Willie was making was what some call the “money illusion.” Willie assumed that because his position was moving in his favor that he had more selling power and more margin. His broker quickly brought Willie face to face with reality. While some brokers may allow it, unrealized paper profits do not truly constitute additional funds that may be used for margin. Willie’s dream of fabulous profits from this trade were just that, a dream. Willie should be thankful that his broker did not allow him to get in trouble. Pyramiding with unearned paper profits is not the way to succeed as a futures trader.

What should be done?

You should realize that each so-called “add-on” to an open position is really a whole new position. Each add-on carries all new risk, and each add-on brings you closer to the add-on trade which will fail and become a loser. When planning a trade, be aware that if the market becomes volatile, margin requirements may go up, thereby defeating any strategy for adding on to your position. There is nothing wrong with building a position one leg at time as prices ascend or descend, but when volatility dictates an increase in margin requirements, beware of trying to add on and be aware that you may not be able to add on.

Option sellers can quickly get into similarly difficult positions. As they roll out to new strikes to defend a threatened short options position, they can find themselves not only facing the need for a larger position, but also facing increased margins in creating that larger position. They may discover that they no longer have sufficient margin to defend a particular position and thus have to eat a sizable loss.

MORE KEY MISTAKES

Throughout our courses we mention some key mistakes commonly made by traders. Here are a few more:

Error: Confusing trading with investing. Many traders justify taking trades because they think they have to keep their money working. While this may be true of money with which you invest, it is not at all true concerning money with which you speculate. Unless you own the underlying commodity, for instance, selling short is speculation, and speculation is not investment. Although it is possible, you generally do not invest in futures. A trader does not have to be concerned with making his money work for him. A trader’s concern is making a wise and timely speculation, keeping his losses small by being quick to get out, and maximizing profits by not staying in too long, i.e., to a point where he is giving back more than a small percent of what he has already gained.

Error: Copying other people’s trading strategies. A floor trader I know tells about the time he tried to copy the actions of one of the bigger, more experienced floor traders. While the floor trader won, my friend lost. Trading copycats rarely come out ahead. You may have a different set of goals than the person you are copying. You may not be able to mentally or emotionally tolerate the losses his strategy will encounter. You may not have the depth of trading capital the person you are copying has. This is why following a futures trading (not investing) advisory while at the same time not using your own good judgment seldom works in the long run. Some of the best traders have had advisories, but their subscribers usually fail. Trading futures is so personalized that it is almost impossible for two people to trade the same way.

Error: Ignoring the downside of a trade. Most forex traders, when entering a trade, look only at the money they think they will make by taking the trade. They rarely consider that the trade may go against them and that they could lose. The reality is that whenever someone buys a futures contract, someone else is selling that same futures contract. The buyer is convinced that the market will go up. The seller is convinced that the market has finished going up. If you look at your trades that way, you will become a more conservative and realistic trader.

Error: Expecting each trade to be the one that will make you rich. When we tell people that trading is speculative, they argue that they must trade because the next trade they take may be the one that will make them a ton of money. What people forget is that to be a winner, you can't wait for the big trade that comes along every now and then to make you rich. Even when it does come along, there is no guarantee that you will be in that particular trade. You will earn more and be able to keep more if you trade with objectives and are satisfied with regular small to medium size wins. A trader makes his money by getting his share of the day-to-day price action of the markets. That doesn't mean you have to trade every day. It means that when you do trade, be quick to get out if the trade doesn’t go your way within a period of time that you set beforehand. If the trade does go your way, protect it with a stop and hang on for the ride.

Error: Having profit expectations that are too high. The greatest disappointments come when expectations are unrealistically high. Many traders get into trouble by anticipating greater than reasonable profits from their trading. They will often get into a trade and, when it goes their way and they are winning, they will mentally start spending their winnings, and may even borrow against their anticipated winnings to take on additional risk. Reality is that you seldom make all of the money available in a trade. I cannot count the times that I had for the taking hundreds or thousands of dollars in unrealized paper profits only to see most of those profits melt away before I was able to or had the good sense to get out. One trader I know had $700 per contract profits in a short eurodollar trade. The next day his position literally imploded on news of a 50 basis point cut in interest rates. He was lucky to get out with $350 per contract. The money from trading often doesn’t come in as fast or as plentifully as you have expected or been led to believe, but the overhead costs of trading arrive right on schedule. False profit expectations have caused aspiring traders to leave their job before they were really successful. The same false hope causes them to lose the money of friends and family. False hope causes them to borrow against their home and other fixed assets. Too high expectations are dangerous to the well-being of every trader and those around him.

Error: Not reviewing your financial goals. Before you make a position trading decision, or before you begin a day of day trading, review your motives and your goals.

Why are you trading today?

Why are you taking this trade?

How will it move your closer to your goals and objectives?

Error: Taking a trade because it seems like the right thing to do now. Some of the saddest calls we get come from traders who do not know how to manage a trade. By the time they call, they are deep in trouble. They have entered a trade because, in their opinion or someone else’s opinion, it was the right thing to do. They thought that following the dictates of opinion was shrewd. They haven’t planned the trade, and worse, they haven’t planned their actions in the event the trade went against them. Just because a market is hot and making a major move is no reason for you to enter a trade. Sometimes, when you don’t fully understand what is happening, the wisest choice is to do nothing at all. There will always be another trading opportunity. You do not have to trade.

Error: Taking too much risk. With all the warnings about risk contained in the forms with which you open your account, and with all the required warnings in books, magazines, and many other forms of literature you receive as a trader, why is it so hard to believe that trading carries with it a tremendous amount of risk? It’s as though you know on an intellectual basis that trading futures is risky, but you don’t really take it to heart and live it until you find yourself caught up in the sheer terror of a major losing trade. Greed drives traders to accept too much risk. They get into too many trades. They put their stop too far away. They trade with too little capital. We’re not advising you to avoid trading futures. What we’re saying is that you should embark on a sound, disciplined trading plan based on knowledge of the futures markets in which you trade, coupled with good common sense.

Joe Ross

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