This is probably the most important part of any trading strategy or account. Without proper money management you will find your account busted very quickly. Remember if I am right 60% of the time I have done well. That means I have to manage my account in a way that I can survive being wrong 40% of the time and I have to be prepared for a string of losses.
How much you should risk on a single trade depends somewhat on how large your account is. Typically I would never recommend risking more that 10% (which is really high) on a single trade. I prefer to be in the 2% range but if you have a really small account you might have to stretch that to make up for commissions. But never over 10% and really that is too much and increases your risk of busting you account. If your account is so small or your commissions so high that you feel you must go over 10% then I suggest trying to see if you can find a brokerage company with lower commissions or just virtual trading until you can build a larger account.
If you have a $10,000.00 account and want to risk 5% then you should never have more money at risk on a single trade than $500.00 (5% of $10,000.00). You might not be able to do some of my condor trades at that level but there are other trades you can participate in. There are also ways you can hedge trades to limit your losses if things go wrong. Which they eventually will.
Ultimately how much money you risk is a matter of personal preference just remember you will be wrong more than you like and you could have a series of losses before a gain.
I don’t think I have ever lost more that 5% of my account on a single trade and that is probably too high. I was heavily trading condors (more on that later) when the the stock market tanked. I had to take some substantial losses in order to close positions before I started getting margin calls. I had gotten greedy and really screwed up. I paid for it. By the time the blood bath was over I had lost my entire gains for the year in my account in 2 days. Just glad I had gains to lose or that would have been equity losses.
Back then I was just trading condors, decided it was the Holy Grail and was almost 90% invested when things went bad. I will discuss this in the condor section, it was not that condors do not work it was just that I had gotten so invested in them I did not have the equity or margin to adjust. Again, I had found something that I was having luck with and gotten greedy without fully realizing what could go wrong.
Written: Jim Dawson
Originally posted on trade4profits.com