Money management is the single most important skill, I want you to develop. Though stock trading is one of the best ways to invest money, if you are careless in managing money, you are doomed.
It is in this arena most stock trading casualties occur. Here protecting your capital is the first step to create capital. Although everyone starts trading only to earn money, “not losing money” is the first concern; earning money comes next.
Absolutely you have no control over profits. You can't fix a limit to your profits. If you know all that is given in all these pages of this website and much more, if you are disciplined in following your trading action plan and if you are emotionally stable and balanced, both in continuous profits and continuous looses, mother market will and shall reward you with great riches.
But you have absolute control over your loses. You can fix a limit to your loses. No body can snatch your money more than you allow. So control the only controllable.
And it is money management which keeps you floating in the ocean of stock trading.
Manage your Money
Money management in stock trading is a way of allocating your funds in various trades. It minimizes your loses and safe guards your capital.
When I say capital I talk about two capitals.
Psychological capital is much more important than cash capital. If you loose a little of the former, then you loose a lot of the later. Your proper money management guards both of them.
A good money management rules should be able address the following questions.
How much a beginner should invest in the beginning and later?
Are you fresh enough for some important learning? If not take a cup of coffee or take a good sleep plus coffee. Get the following straight. Please do not deviate from this guidelines and repent.
Your first investment should be only 10% of your affordable money.
If you loose that you should be able to tell me, 'Hey I lost just a bit. Nothing to worry about.' This money which you can afford to loose is what I call as 'affordable money'.
If you are a beginner, irrespective of how rich you are, just invest only 10% of your affordable money which is meant for stock trading. Let us call this as x amount out of 10x total. (Little algebra. Hi!) Once this investment doubles, you have 2x amount in your trading account. Now put in another 20% i.e. 2x of your available cash. Now you should be having 4x amount in your trading account. As this grows into 8x i.e. double again, add another 2x amount to trading account, totaling 10x. Now you have 10x in your trading account and 5x in your bank account.
Did I confuse you? O.K. I will tell you in a different way. Continue reading.
Let us say you are rich enough to consider a loss of $10000 as affordable. Invest only $1000 as your first investment. When your investment doubles, that is, when it becomes $2000, add another $2000. When this $4000 is doubled, making it $8000, add another $2000. Now you will have $10000 in your trading account and $5000 in your bank.
Now you have a trading investment equivalent to your original affordable money. Plus you have 50% still remaining in your bank as standby.
With all this account and a successful trading experience, you are going to make a good start.
Congratulations! Your probationary period is over.
Once you could get the above result, it proves that you are promoting yourself from a “beginner stage” to an early advanced stage.
Do not invest all the money in a single trade. Always divide your investment into 2 or more equal parts and invest in 2 or more trades. 2 is ideal, 5 is max. More number of trades makes it difficult, if not impossible, to manage. I prefer only 2 open trades at any time.
Take trades which risks only 2% of your budget for that trade. How do you calculate?
This question can also be stated as How do you calculate the number of shares to buy? See that your risk per trade does not exceed 2%.
You buy just so many number of shares which if goes into loss, will not exceed 2% of your investment.
I will explain this with example.
Imagine you are buying a share with price of $20, with stop loss at $19.50 and with an investment of $1000 for this trade. Here your risk per share is $0.50. 2% of $1000 is $20. Divide this risk amount by risk per share. That is $20 divided by $0.50, which comes to 40. That is, though you have got $1000for investment, you will be buying only 40 shares for $800.
Learn to think in terms of percentage and not in terms of actual cash. In the beginning when you are investing only a small amount(say $1000), if you earn $20, you may not get thrilled with that amount of earning. But it is 2% on your investment. 2% profit per week means your money will double in one year! At the same time if you loose $20, you do not feel bad for the loss of that little amount. But again it is 2%. If you keep loosing $20 per week, you will loose all your money in 50 weeks.
How to manage a continuous loss in Stock Trading?
What if your first investment (1x or $1000) is washed away?
You only lost 1x or $1000 out of 10x or $10000, which you were anyway ready to loose comfortably.
Loss of 10% of your “affordable money” never pinches you. Does it? If so you are using your “not affordable money”. If a loss pains you that means that you are overtrading.
When you loose continuously take a few days of trading holiday.Evaluate your previous trades. Learn from your mistakes. If you learn from a loss trade, it will never remain to be a loss.
Invest your next 10% or 1x or $1000. if you learn to trade comfortably with out tension, you will never go out of business. Good money management saves you from bankruptcy.
What if you do not have enough affordable money?
Take a day job. Save enough. Learn. Follow money management. Start trading.
But...Never ever borrow money to start trading in stocks.
Your borrowed money is not your affordable money. It puts you under tension. Your tense mind cannot follow a set path. Emotional mind makes instant decision and breaks the first rule of successful trading, that is, to follow a set of predetermined actions, written down in your trading action plan, based on your research.
Never over trade. Know your limits. If a dollar of investment creates a tension in you and makes you loose your sleep, then you are over trading.
How to manage the profits from Stock Trading?
As you continue trading and continue to make profit, keep transferring half of your profits to your bank account.
Both your trading account and bank account will be growing.
What to do with the profits transferred to bank account?
Good question. Get yourself and your family a nice gift. Spend. Enjoy. After all why do you earn? Learn to enjoy your life as you go along.Look for other best ways to invest money.
Money management helps keep your 'trading account' as well as your 'life account' healthy.
Manage your money. Manage your life.