5 Money Management Strategies for Serious Traders

Laurence TaylorCrush Pro Teams, Crush Pro Trading School, Learn to Trade, TradingLeave a Comment

5 Money Management Strategies for Serious Traders

Trading is surely a numbers game and money management is the most important component of a trading plan. It will determine how much you make, and applying the right one will make the difference between single-digit returns and making the kind of money you deserve. In this article, I’m going to introduce you to 5 money management strategies that you can start using to reach your goals.

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5 Money Management Strategies for Serious Traders

  1. The 2% Rule: Uses a percentage of your capital for each trade.
  2. Fixed Fractional: Trades 1 contract for every X amount of dollars.
  3. Optimal f: Applies the optimum fixed fraction from a set of trades.
  4. Secure f: A more conservative version of Optimal f
  5. Fixed Ratio: Sets a delta to determine when to increase or decrease the position size.

What is Money Management?

Money management is a strategy for increasing or decreasing the position size to limit risk while achieving the greatest growth possible from a trading account. There are good and bad ways of implementing money management, and the right way focuses on both the risk and reward factors on your account. It allows you to leverage the account while balancing risk. Money management can be used when trading any market as it is focused on one thing alone, and that is account performance.

Martingale vs. Anti-Martingale Strategies

There are 2 basic approaches to money management, martingale, and anti-martingale. Martingale methods increase the position size with losses. As the account is in a losing streak the trader will double the position size in order to re-coop all the losses and make a little profit.

Anti-martingale methods are the opposite. The position size increases with wins and decreases with losses.

Martingale Methods

The idea is that a losing streak won’t last forever and once it ends the account will be profitable. However, in reality, losing streaks can go on and on and on, and the trader will be risking everything just to get back to breakeven. Psychologically, it is almost impossible to implement. Martingale methods create geometric risk, not growth. Are you really going to risk blowing out your account on one trade just to make up for all the losses and make a small profit?

Anti-Martingale Methods

Anti-martingale methods increase the position size with wins. This is the type of money management that should be used by traders. When there is a drawdown and there most definitely will be, anti-martingale methods won’t bring the account profitable on 1 trade, but they will control the risk creating a much smaller drawdown, making it much easier to recover. All the money management strategies presented below are anti-martingale methods.

5 Money Management strategies for serious Traders

What type of trader are you?

Before you decide on the best money management strategy for you, it’s important to ask yourself what type of trader you are. Everyone is different and there is no one with the same personality as you. Trading is a very psychological endeavor and as such you need to implement an approach that best fits your personality.

Are you a conservative trader that wants lower risk and stable returns? Or are you an aggressive trader willing to accept higher risk for geometric growth? Depending on your trading personality you can choose a money management approach that fits your style of trading.

The bottom line is, the greater the risk, the greater the potential return.

Fund Management vs. Independent Trading

Fund Managers focus on risk and the amount of money under management, not profit. This may sound counter-intuitive but look at the fees funds charge and it will be clear. Funds take a percentage of the profits made and a percentage of the money in the fund. Since they have many investors, the best way to keep them happy and in the fund is to beat benchmark returns of say the S&P 500. They achieve this by keeping risk low, below say 15%.

Independent traders focus on making money. As they are managing much less capital than a typical fund, they need to make the money work harder in order to achieve their goals from trading. Not having the psychological stress that comes with managing other people’s money, they are willing to accept higher risks in the 30-50% range with the potential to make 100-300%.

Small traders who approach money management like a fund manager are usually disappointed when their results and goals don’t match up. The right money management will help you achieve your goals and make trading worthwhile.

What Money Management is NOT

Money management is NOT risk management.
Money management is NOT position sizing. 

Risk Management addresses the amount of risk you will take on a given trade. Position Sizing addresses the size of the position you will use for the trade. These are ways of implementing money management. Money management will determine whether or not the size should be increasing or decreasing.

Money management is NOT going to turn a bad trader into a good one. It cannot turn a bad strategy into a winning one. If a trader doesn’t have the disciplines required to trade correctly then money management will not work.

Money management will provide geometric growth to your account when correctly trading a strategy with a positive expectancy. A positive expectancy simply means that when you average out all the wins and losses that you make money, you have an edge.

Why is money management important?

Money management is important because it will give you a strict path to follow in order to reach your goals as a trader. If you are too aggressive as a trader, then you will make a lot when you are right but you run the risk of catastrophic loss. If you are too conservative, then you won’t cover the costs of trading or achieve your goals.
The goal as an independent trader should be to make as much money as possible while making sure you don’t blow out your account.

1. The 2% Rule Method

The 2% Rule is an anti-martingale money management method that is based on your account size.

Risk per Trade = Account Balance X 2%

To apply the 2% rule, you can use a position size calculator that is very easy to use that will spit out your position size for each trade with just a few clicks.

This is a conservative approach that focuses on limiting risk and is a good method if you are a new trader just starting out. It will keep you in the game while you build your confidence and valuable experience.
It is also a good method for accounts over $1 million. Larger accounts don’t need to risk as much to achieve acceptable returns.
However, It is not really growth-orientated and difficult to use in some leveraged markets. Traders starting with smaller accounts are willing to accept more risk in order to make more money.

2. Fixed Fractional Method

One fixed fractional method commonly used is to trade 1 contract for each X amount of dollars in the account. X can be set to be a large or small number.

X = $10,000; If Account Balance = $20,000, then Position Size = 2 contract

To apply this method you would begin trading 1 contract, and once your account reached $30,000, then you increase your position size to 2 contracts, and so on.

When X is too large then this method is risk-averse but growth is slow. When X is too small then growth is quick but there is a possibility of catastrophic loss.

3. Optimal f Method

This method was developed by Ralph Vince, and it is a mathematical model to determine f which stands for fraction. The method solves for the optimum fraction from a given set of trades that will produce more returns than any other fraction. This method has great growth potential but susceptible to catastrophic risks.

If you are interested and are mathematically inclined, we highly recommend reading all of his books.

4. Secure f Method

Secure f is a safer version of Optimal f.
The risks have become manageable but at the expense of geometric growth.
Overall, the theory behind Optimal f and Secure f makes a lot of sense, but we aren’t sure of the practical application, except maybe for the World Trading Competition where Larry Williams became the all-time winner turning $10k into $1.1 million in just 1 year.

“Once the highest f is found, it can readily be turned into a dollar amount by dividing the biggest loss by the negative optimal f.

For example, if our biggest loss is $100 and our optimal f is 0.25, then -$100/ 0.25 = $400. In other words, we should bet 1 unit for every $400 we have in our stake.”

― Ralph Vince, Portfolio Management Formulas

5. Fixed Ratio Method

The Fixed Ratio Money Management Method was developed by Ryan Jones and presented in “The Trading Game”. It is a very different approach to money management.

Fixed Ratio focuses on profits made rather than the size of the account. There is just one variable called the “Delta”.

Delta = $1,000; Position size increases when $1,000 per contract in profits are made.

The delta is determined by the max drawdown of your trading plan. If your strategy produces large drawdowns, he recommends a delta of 1/2 the max drawdown and equal to or greater than the max drawdown for low drawdown strategies.

As long as you have enough capital in your account to cover risk, margin, and some breathing room, it doesn’t matter whether you have $10,000 in your account or $100,000, the size of your account is not a factor.

Begin trading with 1 contract and once you’ve made $1,000 in profits, increase the position size to 2 contracts. Since you increase the position size with every $1,000 made PER contract, increase the position to 3 contracts once you’ve made $2,000 in profits.

This method is great for smaller accounts. The risk on the account peaks at the 4-5 contract level and continually decreases as the account grows. It isn’t optimum for larger accounts of over $1 million, but it is a method that will get you there most efficiently. It provides geometric growth without the catastrophic risk!

Below is a table comparing the growth and risk factors of the different strategies:

2% RuleSlowLow
Fixed FractionalLarge X = Slow
Small X = Geometric
Optimal fGeometricHigh
secure fSlowLow
Fixed RatioGeometricLow

“Even a poor trading system could make money with good money management.”

― Jack D. Schwager, The Little Book of Market Wizards: Lessons from the Greatest Traders

Tips to Increase Your Trading Performance

Here are some things that will help you improve your performance that will greatly increase the speed of geometric growth on your account with money management.

Accept the Risk

In order to be successful, you must truly accept the risks. Many traders say they accept them and then fall apart at the first sign of adverse movement against their position. Thinking in groups of trades instead of each trade will help.

Use Real Stop Loss Placement

Anything and everything can happen, all of which you have no control over. The electricity could fail, a new virus outbreak could happen, the Swiss Central Bank could decide to remove their peg again or a new George Soros could wake up and decide to go to battle with a bank.

Have a Positive Reward/Risk Ratio

Understand your strategy and that there is a trade-off between the reward/risk ratio and your win rate. Going after a larger profit might result in the market not reaching it, too small and you won’t overcome your losses. Aiming for a 2:1 Reward/Risk ratio or better and you will make money even if you are right only 35% of the time.

Understand Market Volatility

Markets fluctuate from high to low and back again. Be aware of the volatility of the market or markets you are trading, and adjust your strategy if needed. Normalizing your position size is not a requirement of money management, but psychologically it is a good idea.

Be Aware of Market Correlation

Market correlation is the positive or negative link between different markets. Knowing which markets are correlated, and when they aren’t, can help you in many ways. If you are trading Gold and you want to buy the AUDUSD, be aware that you are essentially making the same trade as they generally move in the same direction.

Be Adequately Funded

Have enough money in your account so you don’t over-leverage and run the risk of catastrophic loss. Figure out what your risk of ruin is and make sure your money management strategy is appropriate for your account size.

Be Smart When Adding

When you are right about the market direction then adding to your position will greatly improve your performance. Don’t pyramid and add extra risk to a good position, follow your money management strategy for adding positions or reverse pyramiding is also an option. The longer the trend continues the higher the chance a consolidation or outright trend reversal is near so decreasing your position size will keep most of your profit in your account.

Have No Position

You don’t always have to be in the market. I repeat. Staying out of the market is as big a decision as getting in. Money not lost is just as good as profits made. If the market is unclear or your confidence is down, review your results, and identify mistakes you’ve made. The pros in every industry practice!

Be Psychologically Prepared

Nobody likes to lose money. Unfortunately losing money is necessary when speculating and making decisions with incomplete information is concerned. At Crush pro Trading we have the systems in place to help you overcome trading’s biggest hurdle.

In Conclusion

Money management is more common sense than rocket science. Well, maybe the Optimal f method comes close. The best money management for you will be acceptable when it comes to the drawdowns that can occur, and one that is a good fit for your personality. Know what to expect from your trading plan.

When should money management be implemented?

Once you have proven that your strategy has an edge and you can trade it consistently, then it is time to add money management. Working with Crush Pro Teams will help you stay focused, and you will grow into a successful independent trader.

If you don’t quit, you win!

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