As I have always said that money management is a component of a complete trading system. In this article, I will paint you a clearer picture on the effect of money management in trading. Furthermore the expectation of trading will brought to discuss here to see how it relates to money management.
In order to get understanding on how money management affects your trading, let’s consider the following example. Although the example is gambling not trading, it is still worth to consider since trading and gambling share many aspects. The following is the example of coin flip to illustrate that why traders need proper money management. Let says if we are betting on coin flip, and we will bet only on heads up.
If we win, each time the coin flip heads up, we will get $2. If we lose, each time the coin flip tails up, we will lose only $1. Since the chances that the coin will land heads up and tails up are 50%, we will simply suppose that if we take a coin and flip it in the air for 100 times, it will land heads up for 50 times and the remaining 50 will land tails up.
Therefore, after we take a coin and flip it in the air for 100 times. The results will be as follows:
50 flips land heads up: Win 50 x $2 = $100
50 flips land tails up: Loss 50 x -$1 = -$ 50
$100 – $50 = $50
According to the example, we end up by gaining profits. If we take it in to consideration, we will see that we have more chance of making profits than losses in long run. We call that this gambling is a positive expectation game. By having a positive expectation, it means must experience a certain degree of positive return.
Now, let’s get back to the money management. From the same coin flip example what will happen if we do not bet the same amount of money every time. According to the Ralph Vince’s “Portfolio Management Formulas”; if our initial account is $100 then if we bet 25% of total account each time, we will get $36,100 after 100 flips. If we bet 51% of total account each time, our account will be dwindled to only $31.
You will see that by changing the amount if bet, the results can be much different. However only proper management is not enough, you will have to get a trading system that has a positive expectation in order to maximize your profits.
Posted in 
Tags: 
