We know that money management can make us profitable in long-term trading, but we want to show you the other side of things. What happens if you don’t use money management rules?
Take a look at the following example:
Suppose you have 100,000, and you lose 50,000. What is your loss as a percentage of the total account?
The answer is 50%.
This is called capital shrinking by traders. Capital shrinkage is the extent to which capital decreases after a series of impaired transactions. Usually refers to the relative high of equity capital minus the relative low. Traders usually record the size of the drop as a percentage.
In trading, we always look for our own advantages. This is also the reason why traders develop systems. Having a 70% profitable trading system is a very good advantage. But because the trading system only makes profits in 70% of the cases, does this mean that out of every 100 transactions, out of 10 transactions, you have 7 profitable transactions?
Not necessarily! How do you know which 70 of the 100 trades are profitable?
You do not know. You may lose in 30 consecutive trades and profit in the next 70 trades. Your trading system is still 70% profitable, but you have to ask yourself, “Can you still trade after losing 30 consecutive trades?”
This is why money management is very important. No matter what system you use, you may suffer a losing streak. Even professional card players may suffer a losing streak, but in the end they still make a profit.
The reason is that good card players manage their funds, because they know that they don’t win every round. They only risk a small part of their total funds, so they can survive a losing streak.
This is what you should do as a trader. The decline is also part of the transaction. The key to becoming a successful trader is to have a trading plan that allows you to survive periods of significant losses. Your trading plan contains money management rules.
You can survive a losing streak by taking only a small part of the “total trading funds” risk. If you follow strict fund management methods, you will become a bookmaker, and ultimately, “you always make a profit.”