What is Money Management in Trading?

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You’ve definitely seen every financial services provider issue this warning: “Trading entails risk and could result in the loss of your capital…” or a statement to that effect. That’s because, naturally, any form of financial investment or trading carries risk. And it goes without saying that no trader, no matter how skilled and experienced, has a 100% profitability rate on all trades. How, then, do you protect yourself from the downside of the losing trades? That’s where money management comes in. 

However, when planning your money management strategies, you must have risk management in mind. It asks the fundamental question: “Why do and should people engage in risk mitigation as traders?” It is what makes trading, TRADING. It’s why we day-trade, scalp, and swing-trade, but the funny thing is we never sit back and ask “What is the goal?” 

Well, the goal is to make profits, obviously! But that isn’t the only goal. No. The goal is also to ensure that a single bad trade doesn’t wipe out your account. This is the sworn purpose of money management in trading.

What is Money Management in Trading?

Money management in trading is the overall strategy for allocating the capital available to the positions you open. It determines how much of your capital you place in a single trade, and the ideal exit levels – the profit target and the acceptable loss level

A good money management strategy allocates a sufficient percentage of your capital per trade to allow for the inevitable losses, guaranteeing that any loss incurred is too small to have any significant impact on your capital. Effectively, it allows you to limit your downside.

The Best Money Management Strategies

As we’ve said, any money management strategy worth considering is one that limits your downside. And whether you’re an experienced trader, or new to trading, chances are, you’ve heard of these money management techniques:

  1. Only invest what you can afford to lose;
  2. Diversify your portfolio; and
  3. Always use set stop loss and take profit targets.

Admittedly, these three money management strategies can be subjective and can vary depending on a trader’s preferences. So, in this guide, we’ll focus on something empirical – the one money management strategy you should use no matter your trading style or preference: proper capital allocation.

Proper Capital Allocation

No trading strategy, no matter how profitable, is foolproof. We all have good and bad trading days, and the sole role of proper capital allocation is to ensure that one bad trade doesn’t blow up your trading account.

The rule of thumb is to spend no more than 5% of your capital per trade. Here’s a hypothetical illustration:

Say your account balance is $1,000. Going by the 5%-per-trade rule, you’ll only be trading $50 per trade – that is 5% of $1,000. That means you’re only risking $50 on one trade.

Now that you’ve allocated a percentage of your capital to one trade, the next step is position sizing. 

Position Sizing in Forex Trading

Position sizing in trading entails determining how many lots you should trade, based on the capital you’ve allocated per trade. To get the optimal position size, you’ll need to account for capital allocation (your account size and risk percentage discussed above) and the intended stop loss (in pips) for a single trade.

You can use the Empirica Signals position sizing calculator to determine the optimal position sizing for you. 👇

Position Sizing Calculator

Let’s break down the implications of position sizing as one of the money management strategies.

Let’s continue with our earlier capital allocation rule of 5% per trade for a $1,000 account. Now, let’s say we have a stop loss of 40 pips for each trade. 

If you’re trading either gold (XAUUSD) or Oil (XBRUSD), the resulting $50 capital allocation translates to about 0.13 lots per trade.

Risk Management with Trading Signals

Empirica Signals ranks as one of the best gold and oil trading signals providers on Telegram, with over 40 monthly signals, over 75% accuracy rate, and more than 1000 monthly pips.

How does Empirica Signals help you with risk management in trading?

Before we discuss that, here’s the basic structure of the signals sent:

Empirica Signals

With over 75% accuracy rate, it means that for every 10 trades, about 3 are losing trades. Let’s model how this will look like in your account.

Suppose your account balance is $1,000, your maximum capital allocation per trade should be $50 (going by the 5% rule).

And based on our signals, the cumulative stop loss is 120 pips (40 pips for 3 positions). In this case, the position size for either gold (XAUUSD) or oil (XBRUSD) is 0.04 lots per position.

Given that there are 3 profit targets in one signal, you’ll open 3 positions of 0.04 lots each to cover each profit target.

Position sizing calculator

Remember, each position has a stop loss of 40 pips which equals a loss of about $16 each. That means, if this turns out to be a losing trade, you’ll lose just under $50 in total ($16*3). As you can see, this severely limits your downside.

Even if you have 10 bad trades in a row, you still won’t be wiped out – but let’s be honest, the probability of having 10 losing trades in a row is pretty low. With this in mind, for your account to be completely wiped out, you’ll need to lose 20 trades in a row. And we just don’t see how that’s possible if you have a consistently profitable signals provider like Empirica Signals.

Now, let’s consider a scenario where you lose 3 trades in a row, and then are profitable in the remaining 7 trades. And for the sake of simplicity, let’s say you’re trading 0.04 lots throughout.

For the first 3 losing trades, you’ll lose a cumulative of $150, ending up with an account balance of $850.

Now, assuming that the remaining 7 trades all hit TP3, that’s a cumulative of 1260 pips gained. Remember, for one signal, the cumulative pips for TP1, TP2, and TP3 are (30+60+90 = 180 pips). For seven signals the cumulative pips are (180*7 = 1260 pips).

Using our profit calculator for gold and oil CFDs, the 1260 pips gained equal to $504 as shown in the screengrab below.

forex profit calculator

In this case, with a winning rate of at least 70%, your net profitability from just 10 signals is $354 ($504 – $150).

So, as you can see, proper risk and money management in trading allows you to ride through the losing trades, long enough for you to be profitable – you live to fight another day.

FAQs

What is money management in trading?

Money management in trading is the overall strategy for allocating the capital available to the positions you open. It determines how much of your capital you spend per trade, and the ideal exit levels – the profit target and the acceptable loss level. 

What is the difference between risk management and money management in trading?

Risk management involves gauging the possible losses associated with a specific trade, comparing it to the potential profits, and devising strategies to minimize the risk of losses. On the other hand, money management primarily involves strategies used to allocate the available capital to individual trades.

What are the best money management strategies in trading?

Money management strategies can be subjective. They include: only investing what you can afford to lose; diversifying your portfolio; setting stop loss and take profit targets; proper capital allocation; and position sizing.