Money Management: 4 Key Parameters to Analyze for Success

Money Management is a fundamental resource for any trader. It is, in fact, one of the few weapons available to manage - not neutralize, that's impossible - the element of risk that is inherent and endemic in the market. Money Management is also a true discipline, with its own rules and dynamics. Above all, it is a complicated and challenging discipline, at times boring. It's a duty, a collateral activity to be carried out alongside the undoubtedly more adrenaline-pumping activity of trading in the strict sense. To learn how to perform proper Money Management, determination, consistency, and a certain predisposition are necessary. It is impossible to provide a complete tutorial here. However, we can list and describe four elements that should always characterize Money Management activities, specifically the verification of the feasibility of trades, or more broadly, the strategy as a whole. Verification that, obviously, must be done a priori.

Equity Line

The term "Equity Line" refers to a graph that represents the way in which the trading system, whether automatic or manual, has generated profits or losses. If the classic report says how much we have earned, the Equity Line says how and when we have earned. In essence, it is a graph that puts time on the x-axis and earnings and losses on the y-axis. How to read the Equity Line? Let's start by saying that no Equity Line represents a parabola or even a straight line. In the first case, the trading system would generate continuous and constantly increasing gains. In the second case, continuous and always equal gains. Therefore, the Equity Line always represents an irregular line, with ups and downs. However, there are two characteristics that the Equity Line must possess to demonstrate that yes, the trading system is sustainable from a Money Management point of view. Upward trend. If the line, despite peaks in one direction or the other, points upwards, it means that in the medium and long term the trader is making a profit, so his activity is economically sustainable. Contained irregularity. Of course, the Equity Line is always irregular, but it is good that it is not excessively irregular. In this case, in fact, it could be deduced that the strategy is dominated by the random element, which, regardless of the final result, represents a dynamic to be abhorred when carrying out any trading activity. Now, the Equity Line can be called into question both before and after starting to use a given strategy. If used afterwards, the graph will represent real results. If used before, it will represent "fictitious" data, or rather data collected during the backtesting phase.

Size Positioning

The term "Size Positioning" defines the activity that allows identifying the most suitable amount of capital to invest in a single trade. It is logically an activity that precedes the actual operation. It is also a crucial activity, as both any losses and any gains will depend on the size of the investment. A reckless approach, typical of the gambler and which has nothing to do with rational and conscientious trading, involves sizing "by nose", generally tending upwards in the hope of making a lot in one go. How to perform good Size Positioning? The techniques are numerous. In general, almost all traders follow a golden rule: never invest more than 2% of the total capital. Now, below 2% there are a sea of possibilities. So, how to do it? A very simple technique consists in starting... From the substance. That is, in defining, numerically, how much you are willing to lose for that single trade (500, 1000, 2000 euros etc). After that, the pips that will be lost in case of activation of the Stop Loss are calculated and a simple proportion is executed.

Win Ratio and Loss Ratio

These two parameters are very intuitive. Among other things, they are closely linked to each other, also because they are complementary, so they can be treated as if they were a single element. In any case, the Win Ratio is nothing more than the ratio, expressed as a percentage, between the number of trades that were winning and the total number of trades. Generally speaking, the higher this percentage, the better the judgment that can be given on the trading system. Obviously, if it is not extraordinarily high, it does not mean that the trading system should be discarded. However, it is good that it does not fall below a certain level. Specifically, it is good that it does not fall below 60%. A similar but "inverse" discourse applies to the Loss Ratio. Which, as easily understood, is the ratio between the number of losing trades and the total number of trades. Obviously, it must not be higher than 40%. Is it better to calculate the Win Ratio or the Loss Ratio? In a sense it is influential, also because calculating one means calculating the other. There are those who, for a matter of psychology, tend to prefer the Win Ratio. Knowing how much you are winning is more comforting than knowing how much you are losing. Win and Loss Ratio can be calculated, a bit like the Equity Line, both before and after putting the strategy into practice. Therefore, either as a preliminary analysis or as a posteriori verification. In the first case, backtesting data is used. In the second case, real data.

Risk-Return Ratio

This is another element of fundamental importance. It can be defined as the ratio between the maximum possible loss and the maximum possible win. The first can only be determined by applying a stop loss. The second can only be determined by applying a take profit. Well, the risk-return must be at least 1:2, although according to some 1:3 or even 1:3.5 is safer. Regardless of the chosen ratio (exact, the choice is at the table), it is necessary to modify one's Money Management accordingly. That is, to establish stop loss and take profit levels functional to achieving that ratio.