Technical Market Indicators
Seven Time-Tested Money Management Rules
to Ensure Survival over the Long Run
1. Preserve Capital. Short-term traders should limit losses to 1% of total capital for any one position. Longer-term traders should not risk more than 5% to 9%.
2. Trade in the direction of the larger trends, with the most emphasis on the Primary Tide that lasts many months or years. In a Bull Market, look only for opportunities to enter long and close long. In a Bear Market, look only for opportunities to enter short and close short.
3. Enter Actual Stop Orders.
4. Short-term traders should exit losing positions before the close of the day (for those whose time horizon is measured in minutes to days). Longer-term traders should also set a time stop appropriate to the cycle they are trying to capture, in order to avoid tying up capital in positions that are not moving as expected. (See my book, Cycles of Time and Price, pages 176-188.)
5. Calculate Bet Size and Diversification. Commit no more than 5% of total capital to any one position.
6. Calculate Reward/Risk Ratio. Enter a position only when your analysis indicates at least 2 to 3 points of potential reward for 1 point of risk. Profit should be more than double the Maximum Draw Down, based on historical simulation.
7. Take a time out from trading any time you lose 5% of your capital. Market behavior can change, and a trading system could stop working suddenly. Taking a time out breaks bad momentum, limits negative spirals into deep holes, and makes it easier to recover from a loss. A time out gives us the opportunity to calmly reevaluate the current environment and our trading system. A few days off helps clear the head, settle the nerves, and puts a break on revenge trading. (The desperate attempt to quickly make back a loss most often leads to more losses.)
Capital conservation should be the first rule in trading and investing. Capital takes time to accumulate, but it can disappear fast if the technical trading rules are not well known and respected. Beginners particularly would be well advised to take these rules to heart and to start trading only a small fraction of their capital using the minimum size orders until they acquire their real-time market education as inexpensively as possible. Ignore this, and the tuition could be substantial.
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Robert W. Colby, CMT (Chartered Market Technician), is a consultant to institutional and private investors and traders. Colby provides custom research services tailored to your objectives, whether they be short-term trading, long-term investing, or something in between. Colby also teaches and speaks at educational seminars, conferences, and workshops. Over his 42 years of professional experience, Colby has become known the world over for his expertise, objectivity, independence, and integrity. Please click here to contact Colby directly.
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