What does money management mean for traders?
Stock trading is constantly changing, so even the best and most experienced investors can not always predict stock prices with certainty. Daring all-in strategies involve the risk of a total loss. If you want to reduce this risk while doing professional stock trading, you need to Master the basics of money management. But what is money management, how does it work, and why is this smart approach the key to trading success?
Definition: What is money management?
Money management is a securities strategy from securities trading. The goal is to skillfully control the risk on the securities account and thus reduce it in the long run. To achieve this, the individual securities are held in the portfolio with a predefined position size. If the post size is exceeded, the excess is sold. If the price falls below a certain value, the entire position is abandoned through a sale.
An investor has a securities account of 1 million euros. To keep the risk of losses as low as possible, the investor limits each position in his portfolio to EUR 100,000. As a result, the invested capital is divided into 10 different positions. If the price of a position increases and the defined limit is exceeded, the affected part is sold until it remains within the set limits.
Why is professional money management the key to trading success?
The primary goal of trading is not value retention, but a positive return. This is exactly where money management comes into the picture. The smart method minimizes the risk of losses and at the same time helps investors to secure profits. It is of the utmost importance, especially at the beginning of a career in trade, to consistently adhere to the established rules and to constantly monitor and analyze them. This not only protects capital, but also improves individual trades over time.
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Important methods of money management in an instant
Professional brokers offer their clients various tools so that they can continuously improve their money management. The methods used in these tools are mostly stop-loss rules, features that calculate optimal position size, account size, or CRV.
Depending on the chosen strategy, it is possible to limit the risk of loss by means of a so-called stop-loss order. A stop-loss order is nothing more than a security order executed when the security falls below a certain price. The rule is usually based on the volatility of the security or other characteristics, although the threshold may be more generous if the security fluctuates.
Position size defines the proportion of capital invested in a new position. The size of the position must be adapted to the risk of the trade. For capital to function, investors should realize several position sizes that are low-capitalized, especially in CFD trading.
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The account size serves not only as a basis for calculating the position size, but also for risk calculation. The money management ensures that the controlled investments ideally constantly enlarge the account. If there are losses, the account size also shrinks, which means that a new risk assessment is necessary so as not to completely destroy the account with a few trades.
The abbreviation CRV stands for risk-reward ratio, whereby investors pursue the goal of maintaining a positive CRV. The potential risk is determined from the difference between the entry price and the stop loss. The conceivable chances, in turn, are the difference between the entry price and the take profit.
Simple rules for money management
To minimize existing risks, the total available capital should never be used in full. A liquidity reserve that can be used in the event of a crisis is therefore an important pillar of the investment. The so-called one percent strategy can also be used to minimize the risk. Only amounts are invested in positions that result in a maximum loss of one percent of the total capital. This significantly reduces the overall risk, although the total losses should not exceed 10 percent.
The difference between money management and risk management
Risk management is a very general term that also deals with risks in the trading market as well as aspects of capital use. In contrast, money management is a particular subdiscipline of risk management. The focus is on both controlled and optimized investments as well as the skilled choice of position sizes, which leads to constant account expansion.
Benefits of Money Management
Money management helps investors use their equity responsibly and wisely. The risk of the individual trades can be managed skillfully via position sizes, although smaller sizes can also be chosen for risky securities. The skilful balancing of risk for loss and profit makes it possible to pursue sustainable value protection and avoid total losses even in difficult times.
Tools that make money management easier
To use money management effectively, brokers typically provide their clients with tools to automate parts of the approach. The digital applications include the option of stop-loss, where some tools also include CRV functions and automatic calculation of optimal position sizes. In addition, customers can also define a maximum loss size per. account for many accounts and perform various analyzes and plans.
With the help of money management, the risk of losing a portfolio can be significantly reduced, while the risk of individual shares can also be limited. Smartly implemented, there is sufficient capital available for trading even in loss phases to take advantage of opportunities that arise in the market. However, investors need to regularly monitor and analyze their money management. This is the only way to make the necessary adjustments quickly and improve the results in the long run.
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