Section VII: Not Using Money Management
Money Management (MM) is one of the essential parts of trading. The main purpose of MM is to avoid the risk of ruin. The lack of using MM is one of the reasons most traders lose their trading accounts.
MM basically answers the next question: how much to risk on each individual trade? It should not be confused with risk and trade management (pyramiding, scaling out, trailing stops, where to place stops, etc.) MM tells you how big or what size the next trade should be.
Most traders just focus on the profit side of each trade and totally forget about the risk side. In other words, they think the trade is a winner before placing it, and therefore they do not pay any attention to the consequences a losing trade could produce on your trading account. But remember, every trade is statistically independent from each other. Although the outcome of a series of trades is predictable, there is no possible way to forecast the outcome of each individual trade.
The best systems available are only right around 60 or 70% of the time. For every 10 trades, there is a possibility to have 3 or 4 losing trades. If we don't pay attention to these 3 or 4 trades, we could end up losing month after month, or worse yet, blowing up (losing) our entire account.
We will never know which trade will be a winner and which one a loser, never. So MM should be applied in every single trade,regardless of what you think the outcome of the trade will be.
Even with a system that is right 90% of the time, you could end up broke if you do not apply a sound money management technique.
MM also helps us in the winning side of every trade, when applying MM techniques we could benefit from the geometric growth of our trading account. As your account grows, you will trade larger amounts according to the MM technique applied.
FACT - If you do not have a system that is right 100% of the time you should us Money Management (meaning you should use it because such a system does not exist), regardless of how big or small your trading account is. We will never know the outcome of the next trade, and this one trade could be the last one if you do not apply MM. using MM is not an option, it is a must if you want to achieve your trading goals. You need to do whatever you need to do to be able to trade the next day, week, or year.
If you want to be in this business for the long haul, apply proper trading sizing techniques.