Here we will show you some chart examples of how we generally manage our SP 500 trades. We do use discretion in our trading as opposed to a 100% mechanical system so the trade management may vary depending on market conditions. Learning to efficiently manage trades is one of the most important skills a trader can achieve.
In the first chart example below the trade was almost picture perfect. The price reversed at the completion of point D and we were able take a partial profit then move the stop-loss order down and exit at a second profit objective to close the trade.
In the next chart example the trade was initiated at the completion of D. The first profit objective was taken and the stop-loss moved down. The remainder of the trade was stopped out at breakeven just before the market turned down for a large move. The trader always has a choice to move the stop-loss order to the high or low of the most recent swing, the downside to this is it will give back some profits if stopped out. The upside is it may capture a larger move.
The trade can also choose to use a one part exit and take profits in one exit using a Fibonacci retracment or other specific exit point.
As with any trade setup there can be failures. We always use stop-loss orders and recommend that traders using these strategies also employ the use of stop-loss orders. Stop-loss orders protect capital and the trader’s state of mind.
Allocating Capital
There are many money management techniques employed for many different trading styles. Money management is one of the most important tools in your trading tool box. It can literally make or break a trader. As an example if one trader has a 70% win/loss ratio and has an average win of $500 but the average loss is $1000 that trader is barely breaking even;
7 wins x $500 = $3500
3 losses x $1000 = (-$3000)
Gross Profit $500
Conversely, if a trader has a win/loss ratio of 50% and has an average win of $1000 and an average loss of $500 that trader will come out ahead.
5 wins x $1000 = $5000
5 losses x $500 = (-$2500)
Gross Profit = $2500
The trader in this example with the lower win/loss ratio is the better money manager.
Another basic example of unacceptable money management would be a trader allocating too high of a dollar amount of overall trading capital to any one trade. A trader without a consistent money management method may have a strong gut feel for a trade, or may have hot tip they are trading from and allocate a large portion of capital that loses.
20,000 account risks 10,000 on one trade and loses;
20,000
-10,000
10,000
Gross % loss = 50%
It will take a 100% gain in the account to get back to breakeven!
It’s important to have an overview and thorough understanding if you trade multiple markets or stocks with multiple open positions at any one time. The trader must look at how all positions losing at the same time would impact their account;
20,000 account example with trader risking 3% per trade:
Long SP 500 with $600 risk total
Short Bonds with $600 risk total
Long Corn with $600 risk total
3 losing trades = $1800 or a 9% loss on the account.
Our recommending reading list includes a book written by Kenneth L. Grant, Trading Risk, Enhanced Profitability through Risk Control, Wiley & Sons 2004. We strongly recommend you read at least this book on money management and develop a money management plan for your trading.
We recommend that as a basis trader’s allocate between 1-3% of total trading capital on any one trade. Using a hypothetical account balance of $20,000 and a 3% risk trading the SP Emini contracts this would allow for a maximum of $600 risked on any one trade.
The stop-loss placement would determine how many contracts a trader can place for each trade. Using a 3 point stop loss ($150) this allows 4 contracts to be traded;
$600
$150 = 4
Using a 5 point stop-loss ($250) this allows for 2 contracts to be traded;
$600
$250 = 2.4
Always round down the contracts if an uneven figure.
We always use stop-loss orders in our trading and we strongly recommend traders use stop-loss orders. Stop-loss orders protect capital and also protect the trader’s mindset. If the trader is suffering large losses and not using stop-loss orders and is unable to use them they should consider stopping trading until they can devise a trading plan inclusive of using stop-loss orders that they can follow. The unwillingness to place stop-loss orders is usually an indication of underlying emotional trading issues. Those should be resolved before moving ahead in trading.
Taking losses in trading is a part of doing business and accepting that as a normal course of action allows the trader to manage their trades as a business.
Following a consistent money management plan will allow the trader to participate in consistent profits and will minimize losses which will grow the account. The trader can then incorporate a plan to add on contracts or shares to their overall trading plan as their account size grows.
