Introduction to Money Management
In Chapters 4, 5, and 6, we went through a development process that resulted in two trading strategies: a short-term scalping strategy for stocks, and a longer-term trend-following strategy for commodities. I discussed the benefits of developing strategies with a limited money management step integrated into the process. When the strategies are fully developed, they still aren’t ready for trading. Another step must be taken to tailor the strategy to the account size to be traded, and the risk/reward appetite of the trader. That step answers questions such as these: What instruments should you trade? How much size do you trade? At what point should you increase your number of instruments, or size? And under what conditions do you cut back market exposure? These issues fall in the realm of money management. The purpose of this chapter is to introduce two money management concepts: position sizing, and small versus large account trading. Then, in the next four chapters, we will develop specific money management solutions for our stock and commodity strategies.
■ Sizing Techniques
Most of the money management literature concerns position sizing. Various methods are used to determine how many shares of stock or how many contracts of a commodity should be bought or sold on a given signal. There are two general types of sizing techniques. The first maintains a fixed size throughout the trading. This is the method we used in your system development ...