Money Management: The Overlooked Ingredient

08/22/00 01:57:42 PM

by Dr. RM Sidewitz

A strong approach to money management can make even a mediocre trading system do well.

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Money management addresses two primary issues:

1. Position sizing -- the number of contracts to trade, and
2. Risk control or preservation of capital.

These are the two most crucial concerns of any trader because they determine long term profitability. Indicator addicts would argue that selecting the right indicator is the most important aspect of trading; I would vehemently disagree. How you control the expansion and contraction of your available capital is, as it is in any business, the true key to success.

Let's face it, many traders are undercapitalized. Some enter the fray with $1,000 or less hoping that all their pipe dreams will come true. A sound money management plan allows you to take your losses and yet return to fight another day. Without adequate capitalization, the inevitable periods of losing trades will force the trader out of the game.

This makes perfect sense. The U.S. Chamber of Commerce reveals that the single reason more businesses fail is a shortage of operating capital. The business of trading is no different. Many individuals who could have been successful traders had to give up because they simply ran out of cash.

Money management answers the questions:

1. How do I balance my desire for capital appreciation against my need for capital preservation?
2. How much capital do I place on any trade?
3. Is there a method to limit my risk?

For myself, I much prefer trading OPMs, that is, Other Peoples' Money, meaning that I keep my position sizes quite small until I have amassed enough profit in my account to be able to add on. Then when I do add on, I am not putting any more of my own money at risk.

As an example, when I trade the Standard & Poors (S&Ps), I'll only trade one contract for each two-times-margin of account balance. This allows me to weather the inevitable swings the index futures experience from time to time without having to quit the game. When my profits equal or exceed two-times-margin, I'm comfortable adding another contract. I increase my exposure, and thereby my risk, only when I'm using previously realized profits.

Controlling my risk is the other piece of the puzzle. Each trader chooses how much of their capital they will expose to any one trade. Here's an example. Let's say I'm willing to risk 10% of my profits on any single trade. So if I add another S&P contract, it means that I'll risk $5,000 to trade it. This type of pyramiding allows me to let my profits grow exponentially while ensuring that I don't wager a disproportionate amount of my capital on any one position.

The above approach is hardly the only way to manage your money; there are numerous others. The point is that you must have a way to allow your capital to grow without attaching undue risk to it. A sound plan for money management can take a mediocre trading system to great heights. In so doing, it will take you a long way toward the trading success that you desire.

Dr. RM Sidewitz

Dr. Sidewitz is the President, Chief Executive Officer and founder of Qi2 Technologies, LLC, an investment management company and the Managing Member of Qi2 Partners LP, a domestic hedge fund. Dr. Sidewitz began his career on Wall Street in the mid-1960s with Moody's Investors Service. He then served as the Assistant Director of Research for a registered broker/dealer until 1971. In the ensuing years, he continued his pursuits as a private investor during which time he developed the proprietary methodology that is used by the Limited Partnership. Dr. Sidewitz is the author of two books, "How I Double My Money Annually in the Market" and "How to Stop Sabotaging Your Trading Success: Mastering the Inner Realm". He is a frequent contributor to numerous financial publications and continues to work closely with private clients.

Title:	Managing Partner
Company:	Qi2 Technologies LLC
Address:	4800 Baseline Road, Suites E104-370
	Boulder, CO 80303
Website:	www.cybrlink.com
E-mail address:	doc@cybrlink.com
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