Trading is a complicated and risky activity that, despite some advertising and illusory messages, has little to do with gambling. Certainly, there's no lack of adrenaline, but the playful aspect gives way to the rational, logical, statistical, and even scientific elements. The highest expression of these aspects lies in two fundamental allies for every trader: money management and risk management. These two disciplines literally allow the investor, on one hand, to protect capital and, on the other hand, to optimize profits. There is often confusion about money management vs risk management, but there are precise differences and diverse areas of competence between the two disciplines.
What Money Management Involves
Money management is the activity that allows optimal management of available capital. It consists of all those techniques aimed at increasing profits and protecting investments. The same discipline looks different across asset classes, as shown in forex against futures.
What Risk Management Involves
Risk management has a more precise value and consists of a set of techniques aimed at putting into practice what was decided in the money management phase from a risk minimization perspective. To be clear, risk management is the determination of stop losses and their placement. For those who don't know, the stop loss is the price reached at which the trader exits the investment to minimize losses. How that mechanism compares across markets is explored in stocks against currencies.
From these simple definitions, it can be deduced that money management intervenes in a previous phase, and risk management in a subsequent phase. Money management is more strategic, while risk management is more operational (although elements of strategy and operativity can be found in both cases, but in different quantities).
Setting a Risk/Reward Ratio
If risk management is exhausted, in most cases, in the work on stop losses (identification, placement, activation), money management may seem more random. A general rule, valid in all situations as it is conventionally recognized, consists of respecting the risk/reward ratio equal to 1:2, or 1:3 for the more prudent.
An "easier" doctrine, only apparently less prudent, consists of ignoring stop losses or simply trying to avoid them. Traders who play for the long term and stay away from the most hectic phases in the market can afford this approach. This is possible because, if you think in the long term, reaching a stop loss (always if you do things right) is unlikely. For everyone else, it is always a good idea to set a stop loss that can pull the chestnuts out of the fire at the most opportune moment. Risk tolerances of this kind also vary by market, a theme covered in forex against stock trading.
