Money Management: The Riskiest Techniques

Why Money Management is Essential

Money Management is a fundamental practice for any trader, as it allows for managing money in both good and bad times. Practicing Money Management, however, means implementing specific actions and utilizing certain techniques. Some stand out for their balance, effectiveness, and real protection capacity. Others, on the other hand, can be deceiving and prove to be very dangerous, forcing the trader to operate with the classic patch that, in reality, is worse than the hole. In this article, we'll discuss some of the most dangerous Money Management techniques. You could use them, of course. If you're lucky, you might even benefit from them rather than be harmed. However, know that in most cases, these two techniques jeopardize the capital in its entirety. But let's proceed in order.

The Purpose of Money Management

Before discussing these dangerous techniques, it's important to clarify the purpose of Money Management. What is the real purpose of Money Management? Its goal is quite intuitive: to provide tools for deciding trade exposure after trade in order to maximize gains and minimize potential losses. A good Money Management system, to be considered as such, must take into account at least two elements. The first is risk calculation, possibly based on reliable statistical data. The second is the analysis of the trader's financial possibilities and resources. It follows that a good Money Management is always and in any case a "personalized" Money Management. That said, we can move on to introducing the two most dangerous Management techniques of all, the ones you should handle with care or (even better) not handle at all.

The Most Dangerous Technique: Martingale

You've probably already heard of Martingale. The fact that it's known even outside of trading doesn't work in its favor, also because it's actually a technique directly borrowed from gambling. The fact is that trading cannot and should not be considered as gambling, unless you want to put your capital at risk. In any case, Martingale refers to the progressive increase in exposure, i.e., the capital invested per single trade. This increase is neither slight nor the result of some complex reasoning. Quite simply, every time a trade ends in failure, the trader doubles the exposure. This means that if you invested 100 on the first trade, in case of defeat, you will invest 200 on the next trade, 400 on the one after that, and so on. What happens in the best and worst case scenarios when using Martingale? In the best case, the trade that finally hits will repay you for all previous investments. Too bad this is an eventuality that doesn't happen very often. Or rather, statistically it would happen, the problem is that before the winning trade arrives, there is a very high probability that the trader has already gone bankrupt. The cardinal principle of Martingale is, in its own way, the logic of large numbers: statistically, sooner or later the trader must hit a successful investment. In practice, Martingale is the cause of truly substantial, essentially irreversible capital losses.

A Slightly Less Dangerous Technique: Fibonacci-Martingale

While Martingale is known to many, Fibonacci-Martingale is a slightly more niche technique. As the name suggests, it is still related to Martingale. Just this should be enough to make it clear or intuitive how dangerous it is. It must be said, however, that Fibonacci-Martingale is a more watered-down version and potentially less risky than Martingale. Certainly, it is more complex, especially with regard to the core of the technique itself, which is the decision-making process underlying every reasoning about exposure. The biggest difference between Fibonacci-Martingale and Martingale proper is the way exposure is modified from one trade to another. In the case of Martingale, as we have seen, you simply double the bet. In the case of Fibonacci-Martingale, on the other hand, a coefficient equal to a number in the famous Fibonacci series is applied to the exposure. Essentially, as losing trades follow one another, the trader moves along the Fibonacci series, matching the multiplication coefficient to a number in the series. Another difference lies in the dynamics of deciding exposure in the case of a winning trade. That's right, the Fibonacci-style version also takes this eventuality into account. Well, if the trader makes a successful investment, they should not move forward in the series, but should go back two numbers, essentially decreasing the exposure itself. It's a way, however patchy, to preserve what has been earned. Not that this method gives great satisfaction, but certainly the fact that the hypothesis of victory is somehow contemplated plays partially in its favor, at least compared to pure and simple Martingale.

Why Martingale and Fibonacci-Martingale are Terrible Techniques

Why are Martingale and Fibonacci-Martingale two terrible Money Management techniques? On an empirical level, it's easy to answer this question. In fact, the simple observation that, especially in the case of pure Martingale, the trader risks having lost all their capital even before incurring a positive trade, given the dramatic increase in exposure from one investment to another, should suffice. The reasons that should lead to a rejection of Martingale and Fibonacci-Martingale, however, are even deeper. The truth is that these two techniques violate a fundamental principle of Money Management, namely the need to tie any decision about exposure to the characteristics of the trader, or rather to their financial capabilities. Here, both Martingale and Fibonacci-Martingale ignore this fundamental element, therefore they do not take into account the specific financial situation of the trader at all. It is therefore not difficult to imagine why Martingale, in reality, is not practiced by experienced traders, except in very rare and precisely circumscribed cases. Rather, Martingale is a technique practiced by beginners, who quickly learn firsthand how dangerous it can be. All this, of course, also applies to Fibonacci-Martingale, which is only a slightly watered-down version.