With solid money management, you increase your chance of increasing profitability, while decreasing your risk.
Here are some key ways to do that.
No. 1 – Know your Risk Tolerance
Starting out, too many traders risk far too much money. They think the first stock they pick will help them retire early. But as we’re all well aware that’s never the case. So, we have to think smart about our risk tolerance level by asking ourselves, “Can I afford to lose $10,000 on a trade? If not, cut it in half, in quarters, in tenths.”
Think about allocation. Unless you’re Warren Buffett, you have a finite number of shares you can realistically buy. Some traders only risk 2% of their portfolio per trade until the trading account grows to a more substantial number. For example, if you have $5,000 in your account, you’d only risk $100 on a trade to start out.
Using this strategy, you make your money last longer than if you blindly invested.
No. 2 – Always Use a Stop Loss
Defining your max downside is another imperative, or the most you’re willing to lose per trade. This helps remove emotion from your trade. If the stop is hit, you’re out – no questions asked. Without a stop loss, you have the ability to lose it all.
With stocks, consider a stop loss of around -25%.
At the same time, we can employ the trailing stop loss strategy, too.
These allow for unlimited capital appreciation potential. As long as your stock goes up, the trailing stop will never get triggered. Meanwhile, your worst-case scenario is cut down to losing, at most, 25% (or whatever parameters you set the trailing stop loss trigger point out).
No. 3 – Diversify
Never put all your eggs in one basket. You trip and fall, and all those eggs are broken… and you’re just about screwed. It’s easier to lose all your money if all of its in one stock. Spread the cash out and diversify in several names with several baskets.
No. 4 – Cut your Losses. Let your Winners Run
A lot of traders choose a target and take profits when the target is met. Others will allow winners to keep running, perhaps using trailing stops as we mentioned above. They’ll also cut losses with stop losses to limit risk. The best way to lose money in this market is to remain undisciplined. Have a plan. Stick with it.
No. 5 – Remove emotion from your trade
Remove all emotion from your trading. That doesn’t mean you have to have ice flowing through your veins. It simply means you need to re-think your strategy. No matter what your emotion says, never allow emotion to dictate your trading action.