Social Trading and Money Management
This lesson will cover the following?
- What is money management?
- The importance of money management in social trading
- Final words
Money management is one of the most important aspects of trading. Not matter how good you are, youre going to lose in many of the financial operations you undertake. Good money management will help you guarantee that even when that happens, you wont have to endure devastating losses. You have to be strict with your investments, otherwise the risks you take will be unjustified. This section will help you learn how to handle things from this perspective and why its important.
What is Money Management?
Money management, as the name suggests, is the act of managing, regulating, handling and otherwise supervising your personal finances. In the context of trading it implies that you have a very firm grip on what you need to do with your money at any given time in order to guarantee that you wont go bankrupt.
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Money management is administered by devising a set of rationally thought out rules. After youve come up with this set of rules, you need to follow it. This involves determining crucial points of your portfolio if you wish to diversify (for example, 10% you trade stocks, 15% forex, etc.), maximum investments you are willing to make on a single trade, the amount of money you can invest in relation to the chances of success and more. Its your personal strategy within a strategy.
Money management is built on the idea that you have to be responsible and follow your own rules no matter. Its especially important to abide by what youve devised in your head when you decide that a deal is a “sure thing” and youre ready to invest way more than you should. Money management will help you to control your own greed. Responsible money management is what differentiates good traders from bad traders and gamblers.
The Importance of Money Management in Social Trading
When you choose social trading, you take the full responsibility for your failures and the full credit for your successes. Of course, it was “that one trader” who gave you a tip, but ultimately you were the one who decided to act, as well as how to do it, how much to invest and more. Even though social trading is simpler than other types, its not as easy as seeing that someone thinks an occurrence is inbound, so you should invest. It takes planning and understanding. This is where money management comes in handy. The information you receive might or might not be accurate, but its your responsibility to know that its quite possible to lose so you shouldnt be reckless. Money management will ensure that you consolidate your profits and cut your losses.
Lets illustrate this point with an example. An experienced trader thinks that the stocks of company XYZ will go up in the near future, so he decides to start buying. Since hes experienced and has made considerable profits in the past six months, many traders decide to follow his example. Among those traders we find A – a responsible new trader whos spent quite a lot of time devising good money management habits; and B – a devil-may-care trader who is after a quick buck and hopes to get via social trading.
They both decide that the tip is good so they, like many others, start buying XYZ stocks. However, B buys a lot more than A. Whereas A follows his money management routine, B decides to basically go all-in. This is the type of move you should never make. Lets say they both win because the prediction was accurate. In this case B will a lot more than A, at least in the short run. However, in the long run you can be sure that at one point Bs gambling style of trading will bring him to his financial ruin. The fact that he got lucky a few times doesnt mean that hes going to be lucky forever.
Money Management Basics
Based on the strategies you wish to employ and your trading style, you are the one who will have to devise your money management rules and develop the habits. However, there are a few things we can help you with. The first thing is that you need to decide how much is the maximum amount you are willing to risk on a single trade. Some traders feel like 1% of their overall portfolio is quite enough. Others think that its sometimes better to go higher, but not higher than 5%. In our opinion, you should never risk more than 3% of your portfolio on a single trade; 5% if youre more than 90% certain in the successful outcome of the trade. This way no matter what happens, you ensure that a few bad trades wont bankrupt you. Always think in the long run – yes, risking less means making less, but if youre good enough at making the right calls, then you wont have to invest more. And if youre bad, this will protect you (at least for a while) and hopefully help you to figure out your mistakes.
If you want to copy a trader, never dedicate more than 10% of your portfolio on a single trader. Also, its a good idea to test him for a while in your demo account to see if he will actually make you at least some money in the short-term. If he doesnt, then you can decide if youre willing to wait for a long-term strategy to pay off and if its worth the risk.
Be firm and disciplined. Find the rules that match your style of trading the best and then follow them. There is no other way to become a serious trader.