Essential Trading Money Management Strategies
by:
BMA Editorial Team 3
Two well known traders, David Jenyns and Stuart McPhee, discuss trading money management and how to pick stocks with the potential to do well in a bull market.
David: We have quite a good understanding of money management and the rules. What happens when you try and apply those money management rules to leveraged products? A big question is, we're talking about what our maximum risk is, for example the number two percent is commonly thrown around.
When you're trading leveraged instruments, what are your thoughts on how do you calculate what your float size is? Do you look at what you are actually trading or would you look at the leveraged value of what you're trading?
Stuart: I personally think you need to look at what you're exposed to. You could walk in and say I've only got $5,000 here, so I'll just deal with that. No, when you start trading with perhaps ten to one leverage, you're not exposed to $5,000, you're exposed to $50,000 and that's how the market will deal with your situation.
We talk about double-edged swords, and that's what leverage is. It provides fantastic opportunity and potential, but you cannot take that and ignore the other side. And the other side is the increased risk you're taking.
I personally believe you have to deal with the leverage, the total, the larger of the two because that's ultimately what your exposure is.
David: Perfect. A lot of new traders are attracted by only one edge of the sword. They're attracted by the idea of that potential huge gain but there's also that potential for a huge loss. So really you need to understand trading money management, start with those unleveraged instruments first, and prove yourself there before moving on.
The next question is how to pick a range of stocks with potential in a bull market and then the process of trading call and put options.
Stuart: I look for things that are already established in uptrends, and don't mind buying things in highs. An alternative to that is seeing a stock trading in a range, just moving sideways over an extended period of time maybe over months. It may be moving in a narrow trading range, bouncing back and forth, not going anywhere, just going sideways and then heading for a break high from that maybe for a few weeks. So it's clear from that the trading range, or consolidation range and then maintain that break.
A lot of people look at that for an opportunity and I think that's technically quite sound. Personally I look for the ones that have already proved themselves and demonstrated their capacity to move higher and perhaps broken from that trading range, and the longer that trading range the longer the potential upmove when it does break.
About options, they are a leveraged product and they can bite should you not know what you are doing. With CFDs versus options, options have so many more factors to consider, so there's so much more to learn.
Probably the biggest one that people aren't aware of is time decay and how that can impact on the price of the option. But there are all these other things, how volatility the underlying security affects the price and the huge pricing model they use for options. Options can be quite a complicated thing to trade. They provide a great deal of flexibility, allow you to trade both directions but they are not easy.
Like any leverage, do the basics, do the homework, prove yourself doing the stocks. They're the easiest. Do that for a period of time and then move on to something else. An understanding of trading money management should underpin all of this...
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