Online Trading and Money Management: 6 Rules to Follow

Money management is an essential component of online trading activity, or at least it should be. If capital is not managed according to the criteria of prudence and rationality, one is exposed to the risk of transforming trading into a kind of gambling, a phenomenon that leads to an almost certain consequence: disaster. Managing money, when it comes to online trading, means above all identifying, in the most effective way possible, the right amount to invest, trade by trade. But it also means adopting an effective approach to how capital is understood. The issue, therefore, also has psychological implications. The discipline that regulates money management is called Money Management. It is not an easy discipline to master, also because it often clashes with the trader's more instinctual side. Very often, Money Management techniques, and all the actions that proceed from them, force the trader to strain himself, to go against his intuition. In this article, we talk about money management, illustrating six of the many rules to follow, concerning the identification of the amount to invest from time to time... And not only.

How to manage money, a general principle

Before illustrating the six rules, it is good to take stock of Money Management. Above all, its importance. Many beginner traders or aspiring traders make a tragic mistake: thinking that Money Management is a collateral activity, somehow accessory, an extra protection, supplementary to online trading activity. In this way, however, they underestimate its importance, placing it in the background at key moments, when money management should take on the appearance of an absolute imperative. Typically, this approach leads the trader to design trades that are not wrong in themselves, but very dangerous from a financial point of view. It is not uncommon for a trader with little awareness of the importance of Money Management to launch into trades that, while potentially earning high figures, also potentially lose even higher figures. The game is often not worth the candle, and the only way to understand it in advance is to effectively wield Money Management. Hence, the absolute centrality that money management and Money Management should cover. Those who have been trading for some time know this, perhaps because they have learned it the hard way. Beginners who see Money Management as a collateral activity, or even a boring series of precautions, quickly learn at their own expense. And so it is better to develop the necessary awareness right from the start, and learn the lesson without having to bear the highest price. Having made these clarifications, we can illustrate six money management rules that can be useful to the trader, obviously from a Money Management perspective.

5 rules for money management

Identify a maximum percentage of capital to invest in a single trade

To be clear, this rule does not suggest identifying the capital to invest by simply calculating a percentage of the total. The formulas behind this decision are often very complex. Very simply, it suggests setting a limit, and not exceeding it for any reason in the world. This limit can be "mobile", i.e. change in absolute terms. That is, it can correspond to a percentage of the total capital. What percentage? It is up to the trader to decide, based on his needs, requirements, ability to tolerate (losses), and financial availability.

Pay attention to debts

Actually, this is a maxim that could apply to any activity, daily or professional, whether or not it concerns online trading. However, in online trading it takes on a particular connotation. The issue revolves around the concept of "quality of money". Money is not always the same. In fact, depending on the origin of the money, those who use it behave differently, assigning it more or less importance. Basically, when money is borrowed, the individual tends to consider it with greater nonchalance, and this also happens in online trading activity. Hence, the usefulness of using only one's own money, perhaps earned by one's own sweat. Only in this way will the right importance be given to capital, and it will tend to be preserved as much as possible.

Reserve capital for extraordinary occasions

This is advice that few give, but it allows for a considerable increase in opportunities. Those who adopt Money Management approaches, recognizing their importance, often do so rigidly. Instead, a bit of elasticity is also needed in this case. Such elasticity can be expressed through the composition of ad hoc capital, a kind of fund reserved for special events, i.e. unforeseen market phases that present opportunities. In this way, two objectives are achieved: on the one hand, it is possible to seize opportunities that would be precluded with a stringent approach to Money Management; on the other hand, it is possible to do so without it weighing on financial availability, even if such "sudden" opportunity is not seized.

Pay attention to false breakouts

This is advice halfway between Money Management and Risk Management. It consists of being wary of volatility that emerges outside of a precise trend. Volatility in a lateral phase, in fact, often generates false breakout signals. Movements that seem to herald the beginning of a trend, or the reversal of a very weak trend, often result in nothing. Under these conditions, it is best to keep your portfolio tightly closed, or reserve only a small portion of capital for operations. It is a matter that concerns market understanding, of course, but also money management. The fundamental principle is to avoid investing too much on signals that are inherently uncertain. Also because a signal that arises from uncertainty, is more likely to prove false, with all that follows in terms of capital loss.

Modulate risk based on trading activity

This is valuable advice, as it allows for a conservative yet sufficiently flexible approach. Specifically, the suggestion is not to approach risk always in the same way, but to do so based on the quantitative characteristics of one's trading. It is, in a nutshell, a matter of risking less per trade if the trading is frenetic. This translates into a rather simple rule: if you trade a lot, invest a low amount for each trade. The "how much" is a knot that each trade must untie autonomously, taking as reference, as usual, one's needs, trading style, objectives and economic availability.

Make mistakes, but take note of your errors

This is a principle that can apply to any complex activity, and that requires advanced skills. Obviously, it is also useful in an online trading perspective, and especially when it comes to managing money. In this specific case, this principle translates into the use of specific capital allocation formulas. There are many, some as simple as the Kelly formula. The goal should be to identify the formula that is most congenial to one's trading style and risk profile. In the initial phases, and even better if in a "controlled and safe" environment, such as a demo account, you can even afford to make mistakes. The advice, however, is to keep a diary where you record all the actions performed, and all the tools used. After some time, you will be able to produce a balance sheet, and finally understand which Money Management technique is most suited to your online trading activity.

Find your way

Finally, a general rule: modulate Money Management based on... Yourself. In short, as far as possible, personalize the Money Management plan. Obviously, there are cardinal principles, rules that must always be followed, imperatives that cannot be subject to any derogation. However, Money Management is, or at least should be, an elastic discipline that adapts to those who wield it. Everyone can tailor Money Management to themselves, based on their needs and way of trading. In fact, they should. Not that it is simple. For beginners, it is difficult to follow pre-packaged Money Management techniques, let alone modify and adapt them. However, it is a path that is undertaken, however perilous and fraught with obstacles. At first, you are likely to make mistakes, and suffer an economic backlash, but the advice is not to give up. The beacon should be the awareness that yes, Money Management is important, and deserves all the intellectual energy that one is able to lavish.