Tuesday, April 29, 2008

Dr Elder's Money Management rule

There are 3 basic parts to successful trading: Method, Money and Mind.

We call this the 3M approach to successful trading. I first read about it in a Dr. Elder's book. They are like the 3 legs that a stool should have. Saw any of the legs off and the stool will topple.

So how do you manage your money since money management is such an integral part of trading? Let me present the 2% and the 6% money management rules to you. The 2% rule states that the maximum amount that you should risk in any given trade should not exceed 2% of your total trading capital. The 6% rule, on the other hand, states that the total amount you are risking at any one time in all your trades should not exceed 6% of your total trading capital.

Let me elaborate with an example. So if I have a $100,000 trading account, what is the maximum amount that I could risk in a trade? The answer is $2,000. Now, that doesn't mean that I can only go buy $2,000 worth of equities. I can definitely buy more than $2,000 worth of equities. But the risk (entry price - stop loss) should not be more than $2,000.

This is an area of confusion for some traders which I hope I have helped clarify.

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