Money Management

By: Dr. John Trapp | Wed, Apr 14, 2010
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I am well-qualified to speak on money management, because I've made all the mistakes; and just to keep current, when I'm not being disciplined, continue to make the same mistakes over and over. I've had requests to make some comments on money management. I won't rehash what you can read in any book. What I'll do in this short commentary is give some practical advise that I have learned over the years. This advice is directed toward trading ES, and not traditional investment with large portfolios.

Let me give a little background on ES so that some who are new to trading this product might understand it better. I will be doing a sticky post later to explain in even more detail how the E-mini contract works. ES is the commodity ticker symbol for the E-mini S&P 500 contract. It is traded on the Chicago Mercantile Exchange's (CME) Globex electronic trading platform. It is one fifth the size of its big brother - SP. ES was designed for the small trader, but because ES is traded on an all-electronic trading platform, and is much faster than trading the full contract (SP), even large hedge funds prefer trading the E-mini. The bottom line for us re: money management is that it is a highly leveraged trading vehicle that can make and lose money fast. Just how leveraged you are with the E-mini depends on the discount futures house that you trade through. I use MB Trading, and they just recently lowered the margin requirement for one contract. I can trade one contract of ES for every $1,406 that I have in my trading account. So, if I have a $10,000 trading account, I can trade 7 contracts. That's a lot of leverage! Requirements for carrying your positions through the 16:15 close are another story. With my broker, a $10,000 trading account will only allow me to carry one contract through the close of the day. With MB Trading, I can carry one contract for every $5,625 (initial overnight margin requirement) through the end of the trading day without incurring a margin call. Then, if the trade begins to go against me during the Globex overnight session, I need $4,500 per contract to maintain that trade without getting a margin call. From a trade and money management perspective, that means that if I am trading a number of contracts beyond the initial overnight margin requirement, I will be forced to liquidate some of my position before 16:15. Since I don't like being forced to do anything while trading, I prefer to have a larger trading account and trade only the number of contracts that can ride through the 16:15 close of trading. That is just a personal preference and should not be thought of as a rule. When I am scalping for a couple points, I ignore that rule and often load up if it is an extremely high probability trade. My first piece of advice that should be a rule is to not set up a futures trading account with money that you can't afford to lose. My second piece of advice that I would categorize as a realistic mindset is don't swing for the fence on every trade trying to hit a home run. Go for the singles! You want to learn how to generate a consistent daily revenue stream by taking only the highest probability trades that you can identify each day. Let's say that you have a $10,000 trading account and you have become very consistent in generating $300 a day with stingy money management that protects profits and mature trading skills that knows when to stop trading and stand aside. With about 200 trading days in a year, that would be $60,000 in one year or a 600% return. That would make you an extremely successful trader. There is one thing that is the greatest enemy to becoming a fraction of that trader, and that is drawdowns. Drawdowns happen when you are not managing your losses with stops.

I get a lot of questions about stops. I'll tell you my general philosophy on placing stops. Everyone needs to develop their own philosophy that fits their particular trading style and emotional limitations. First of all, you must use stops! Make that a rule. Now here is some good news that should give you some peace when trading. You should expect to be stopped out with predictable losses fairly regularly. It's an essential part of trading. Stops will keep a trade from becoming an investment, where you hope the market will come back to your entry level so you can get out without a large drawdown. Unfortunately, more often than not, the pain becomes so intense or the margin calls so high, that you take a really big drawdown and go into trader's depression for a while. You find that all your progress for months is wiped out in one trade. Sound familiar to anyone?! You vow to never do that again, and you don't until it happens again on that trade you knew was a sure-thing, and you didn't want to admit you were wrong. And the cycle goes on. Learn to accept small, managed losses and feel good when you do. Because small losses are an important part of a successful trading career. Trading is about making money, not being "right" on every trade.

So, where do I put my stops? First of all, my trades all have a rationale behind them. I either expect the market to reverse for a good trade, or I see a high-probability continuation trade. Below is a sequence of charts that shows an example of where I put a stop in a fairly typical trade setup I look for. First of all, let me tell you what I don't do. I don't just select an arbitrary value like 3 points or 5 points for a stop. That may be too much or it may be too little for the trade that is being contemplated. The charts are annotated and self-explanatory. This is a trade that I remember taking. It was intended as a scalp and therefore not a trade that I would announce on the site.


Using this method of determining stop levels, usually means that my stop will be placed one or two ticks beyond a previous swing high or low. This is my primary method of choosing a stop level. Stops are placed at levels that will nullify the rationale for the trade. The next decision I have to make is whether the risk to expected reward ratio is acceptable. This gets down to simple math. If you are only right 50% of the time on a trade, you will want the reward to be much greater than the risk. That represents a level of analysis that can be matched by flipping a coin. You better have some excellent money management skills! But if you find that your track record is such that you are right 75% of the time, then a risk:reward ratio of 1:1 will work. Some excellent traders will tell you that you can't really estimate reward because it can't be determined. They must not use EW analysis.

I recommend only taking the highest probability trades you can find. Inexperienced traders feel like they have to be in the market all the time. They don't want to miss a move. This mentality will shrink your trading account fast! Don't feel badly if you miss a move. Nobody catches them all. Don't' feel badly if you don't capture the whole move. It's rare to nail the bottom and the top of a move with a trade. There will be more good trade setups today or certainly by tomorrow. When you get stopped out, don't be overanxious to take a trade to get that loss back. Take your time! Patience is a great virtue for traders. If you recognize overtrading as a weakness of yours, try this. Allow yourself 1 or max 2 trades a day for one week. If you do this in a disciplined manner and don't cheat, you will begin to learn how to wait for the best setups. Then when you see how much of a difference it makes in your trading account, taking only the highest probability trades that you have patiently waited for, you may discover something you weren't expecting. Fewer trades are resulting in more profit at the end of the day. Some traders pretend they are trading someone else's money, because it makes them more cautious and conservative in their money management and trade selection.

Have you ever tried paper-trading and noticed how well you did? Then with all your newfound confidence and dreams of becoming the next Jesse Livermore, you jump into real-money trading with both feet. Before long, you are completely discouraged because you are no longer rolling the profits in like you were when you were paper-trading. What happened? Real money! Real emotions! Fear and greed enter the picture when real money is on the line. So, here a the money management rule to help cope with this dilemma. Remember how you felt when you were paper-trading and don't risk an amount that will take you out of your paper-trading response to market action. You want to trade unemotionally - like a machine. Get rid of the emotional highs, and the emotional lows in your trading. If you are trading an amount that exceeds your emotional limits, you will take profits too quickly and you will let your losses run. Some traders can trade 500 contracts with nerves of steel and others can't handle typical market fluctuations with one contract. You need to find out where you are.

One of my purposes in writing this commentary is to let everyone know that we all have common experiences as traders. But we can learn from each other and minimize the pain. Did you ever see the Peanuts cartoon where one of the characters is looking at a sign that has a big circle and an "X" outside the circle. There is an arrow pointing to the "X" outside the circle that says, "You are here!". Then there is an arrow pointing to the large circle that says, "Everyone else is here!". Sometimes we feel that way. Well good news! We are all in that circle. And therein lies the power of a site like this. We can share our common experiences with other committed traders, and not feel so alone in our trading as we mutually support one another and share our insights in the market for that edge we seek. My goal is to provide an edge. I know the market won't follow all my primary scenarios. Nobody can see the future. But if my analyses are right more than they are wrong, then with proper money management, we can profit as traders. I can't tell you how much I benefit by being associated with a group of committed traders like the one we have assembled at MortiES' Site.

This short commentary is not meant to be exhaustive. Hopefully, it will stimulate a focus on the importance of sticking to a money management plan. I am leaving the comment section open on this sticky for now to allow others to add their own perspectives. Think of this as more of a fireside-chat than a thoroughly researched and thought out exposition on the topic.

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Dr. John Trapp

Author: Dr. John Trapp

Dr. John Trapp a.k.a Mortie

Dr. John Trapp a.k.a. Mortie

Dr. John Trapp a.k.a. Mortie for Value of Perfect Information who offer stock market commentary, fundamental & technical analyses on the financial markets. Try MortiES' 30 day free trial. Visit:

A little about myself. My name is John Trapp and I write for the "Value of Perfect Information" exclusively. Trading didn't look too difficult to me 22 years ago, so I began trading October 1987. After that experience and a break from trading, I tried again. This time I was going to be a Bear. Perfect for the 90's. So I didn't have a great start as a trader. I paid a lot for my trading education. I was thrilled when I could finally break even on a regular basis. Trading is an avocation for me - one that I take seriously, and one that I consider the most difficult endeavor I have ever undertaken. I have a lot going against me as a trader. I was a Marine officer in Vietnam and fought in the Ashau with a Battalion called "The Walking Dead" ~ and so, like most combat Marines, I'm too aggressive. I'm a Doctor (one of the Dental specialties) ~ and everyone knows they are the worse investors/businessmen. I am a perfectionist and hate to be wrong ~ so I have a tendency to want to fight the market. Overcoming these liabilities makes the prize more rewarding. I'm still a work in progress, but am making headway. I think I have a lot of good advice for new traders. If I would follow my own advice more consistently, I would be a far better trader also. This is the article and charts my premium subscribers received this weekend.

Value of Perfect Information: Combined, the authors are providing you the investor with various and differing stock market commentary, fundamental and technical analyses on the financial markets that you can utilize to get as close to the "Value of Perfect Information" as if you had tomorrow's financial paper in front of you today. Perfect information would practically mean that all investors know all things, about all stocks, at all times, and therefore always make the best decision regarding investments; in a small way, the authors are attempting to provide you with this "Value of Perfect Information". Enjoy!

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