The first and most important rule of trading real money is to use only “risk money.” Risk money is money that you can afford to lose. It would not make you happy if you did lose it, but your life would go on without any change. In other words, risk money is money that is not needed for any necessity. As we transition from paper trading to real money trading, we must not use the rent money, mortgage money, grocery money, car payment money, insurance premium money, or tuition money. If that is all we have, it is not yet time to trade real money. Using money to trade that is needed for some necessity is dangerous and can cloud judgment. It places undue pressure on us.
As we begin trading, we must understand it is a business; successful traders rarely are gamblers. They do everything they can to put the odds in their favor. In addition to using only risk money, they carefully manage the money they are trading. One way to manage money for the beginning trader with a small account is to make equal dollar trades. If the trader is starting with $5,000 for example, each trade might be $500 or $250. What we do not want to do is make one trade $2,500 and the next $250. How could we possibly know which one is going to be successful? Generally, the nature of Law goes into operation and we have a big loss on the $2,500 trade and a small gain on the $250 trade. Trading in that fashion soon takes the trader out of the game. Our first objective is to stay in the game. Making equal dollar trades helps us do that. Even if we lost all the money risked on one trade it would not be the end of the world. Of course, if we have a good exit plan, it would be unlikely that we could lose everything invested on the trade. On the other hand, if we placed a large portion of our money at risk on a single trade, it could end our career.
That sad story is all about money management and greed. If we manage our money properly, we remove a large part of the risk and prevent our greed from enticing us to do what the fellow in my example did. As we begin to trade real money, we are still building our confidence. Our paper trading may have been very successful, but it just is not the same. Now, something important is on the line. Take it easy. Build confidence with equal dollar trades. If you lose part of your money on a small trade, so what? You will have losing trades so keep the losses small.
I believe an even better way to manage trading money is to use equal percentage trades rather than equal dollar trades. That is difficult to do with a small account, but can definitely be utilized as your account grows. I personally favor making trades where only 3% to 5% of risk money is placed at risk in any given trade. When losses are incurred and the account value drops, the next trade automatically is made for a lesser amount and when gains are made, greater amounts automatically are invested.
This seemingly simple device of managing money can build confidence, protect assets, and enable the trader to stay in the game.