Why You Will Absolutely Fail in Trading If You Don't Master This...

There are many misconceptions about money management. Most think it means trading with stops -- but that is only a small part of it. Below is an excerpt from a dynamic complimentary report, titled "How to Safely Double Your Profits in 2009 Trading ETFs." This little tip alone could save your trading account...

Why use risk controls? Every trader/investor must guard himself against drawdowns -- i.e., the percentage drop in his account size after one losing trade or consecutive losing trades.

For example... Imagine that, after losing a few trades in a row, your $20,000 account is reduced to $12,000: that would be a drawdown of 8,000/20,000 = 40%. If I were to ask some new traders, "In order to be back up to $20,000, what percentage return do you need to generate?" Many would answer, "Since I lost 40%, I have to make back 40%!" This couldn't be more wrong!

Note that, after losing 40%, the trader now starts with a lower base: i.e., to undo the $8,000 loss, the return he needs to generate is 8,000/12,000 = 66.6%!

The more severe the drawdown, the harder it becomes to undo the damage -- as shown in the numbers below:

DRAWDOWN % ... % REQUIRED TO GET BACK TO BREAK-EVEN
10% ... 11.1%
20% ... 25%
30% ... 42.8%
40% ... 66.6%
50% ... 100%
60% ... 150%
70% ... 233.3%
80% ... 400%
90% ... 900%

That is why all professional money managers only risk 1-2% per trade. It's because, no matter how good your trading system is at some point, it is a statistical fact that you will have 10 losers in a row. Based on risking only 1-2% per trade, this is only a 10-20% drawdown and easily recovered.

A full 99% of the hyped-up trading and investing courses in existence don't say or do this. They say risk 5-10% per trade. It is wrong, and will cause you serious financial pain if you follow their advice.

Many of them also use arbitrary stop-loss advice. For example, they say, "Place your stop at $100.10 because that is on the other side of a major support or resistance, trend line, MA, etc."

This makes your risk based on the size of the stop. That is also wrong, because the risk can be too large and it's not the same risk on each trade.

Others reverse this and say, Risk only 2% total, period, and let that determine your stop. This is also wrong, and will hurt you because it is important to have the correct technical stop.

The answer is to do both. Use a percentage and technical stop together.

It works like this: Let's say the technical stop is $100.10. But, based on your entry price, that is a 3% risk. Since your plan calls for a 2% risk, you simply lower the number of shares you are trading. This lets you stay within your 2% risk and have the correct technical stop. This is exactly what most professional money mangers do.

Some say that this will lower their profits, because of trading fewer shares. So what! Study the numbers above again.

You know the old quote, "More risk equals more reward." Well, it's not always true. Sometimes more risk equals more risk! If you lose your money, you have no chance to make a profit. Even losing 50% is disastrous, because you would then need to make 100% to get back to even.

As Warren Buffet says, There are only two rules in investing. Rule #1: Don't lose money. Rule #2: Don't forget rule #1.

I'd like to add a third rule: Correct money management and position sizing must be mastered to ensure your long-term success.

The good news is that it is easy to have correct money management and position sizing. I just explained how to use a combo of a percent [%] stop and a technical stop. If you want more of an explanation, please visit the Free Videos area on this homepage, and click on the "Why have risk controls" article/video title.

The system of entries, stops and profits-taking is only half of your key to success. The other half is money management. If you get this part wrong, you will lose your account every time -- regardless of how good your system is.

Click link below for the free newsletter on how to safely average 6% per month trading Exchange Traded Funds [ETFs]:

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