• Volatility This is related to market action. The wider the swings, the more volatile a market is.

• Winning trade A trade that produced a profit once the trade is over.

Using Basic Money Management in Trading

Probably the single most important money management concept in trading is determining the number of contracts to trade. While no one approach is the best, some guidelines to follow include looking at margin requirements. Each futures contract has a posted margin that you must have in your account to trade one position for that market. These margins are posted by the exchanges that the market trades in. The exchanges constantly monitor the markets and margins can be raised or lowered. Margins generally rise when a market becomes more volatile. An example in the Deutsche mark futures is a margin of $1,250. This is the minimum to trade one contract.

Maintenance margin is calculated to determine how much you will truly need once a position is established. Most beginners trade using the margiftposting in the following way. They will reason that a $10,000 account can trade eight ($10,000 / $1,250) Deutsche mark futures. This approach is entirely wrong because of the markets volatility and the leverage involved. An account can get wiped out very quickly using this formula. Therefore, most people use a factor of the margin such as two or three times margin per position. If the margin is $1,000 and you use a three times factor, you would trade one position for every $3,000 you have available.

Another method is to allocate a percentage of your account per trade. For example, if you allocate 2 percent per trade and you have a $ 100,000 account, that would be $2,000. On a contract that has a $1,000 initial margin, you could trade two contracts. The problem with this technique is that when you- have a small account, say $10,000, a 2 percent allocation is $200. There are no markets that have a margin that low. For smaller traders, a suggestion would be to set a plan according to the amount of money you have to trade. If you have a $10,000 account, you may decide to trade two markets and only one contract per market. Every time the account grows by $5,000, you may add another contract or keep the contracts the same and add another market to trade. There really are no hard-and-fast rules. Just be very conservative when starting, and remember that if you are trading well, one contract can make you a lot of money. Perhaps wait until your account size has doubled before adding more contracts. When you experience a series of losing trades, you will be glad that you are trading conservatively.

Determining what markets to trade is a more subjective task. Here are some suggestions:

• What areas interest you? Does the stock market get you excited? Interest rates or foreign currencies?

• What is your trading method or trading system? Is it short term? Long term? Trend following or countertrend? Some markets historically trend better than others.

• Always look for liquid markets because they give you the ability to get out if you so choose. Remember many markets have limit moves and these limit moves occur fairly frequently. Once a limit is hit, no further price movement can occur in the same direction, thereby killing liquidity.

• Are your system results based on a basket of markets or are you focused on one market?

• The last and most important thing to consider is the amount of capital you have to trade. You may love the stock market and want to trade the S&P 500, but if you only have $8,000 to trade, you cannot trade that market. The margin for the S&P 500 is $10,000 per contract. Based on the money you have available for trading, look to the markets that suit your trading and fall within your money parameters.

Advanced Money Management

What most traders do not realize is that the same time and precision they put into their trading and system development, they can also put into money management strategies and techniques. The same techniques that you use to analyze the markets can be applied to equity and money management.

Equity Charts

Next to the actual market charts, equity charts are the most important charts that a trader can keep. Equity represents the profit or loss on a given trade added to the previous equity value. If you ever notice the nice advertisements for systems for sale and a chart that looks like a rocket taking off, this represents the equity chart of that particular systems trading results. An uptrending equity line represents a series of profitable trades; for example, +$200, +$300, +$500. A downtrending equity line represents a series of losing trades; for example, -$100, -$500, -$300.

Generally, the trader or system being tested starts with an initial equity amount, say $10,000. As trades are closed out, the outcome (profit or loss) is added to the initial equity and a running total is kept. Figure 7.1 shows an uptrending and down-trending equity chart. As trades accumulate, an equity line forms that looks similar to a line chart of a particular market.

You should analyze your equity very carefully to get an idea of how your trading is faring. If you are trading well, the equity line should be uptrending. If the trading is poor the line will be falling or downtrending. If your results are mixed, the line will be moving sideways. Each of these scenarios can be very insightful to traders who can step back and look objectively at the results. Uptrending equity charts are what we all strive for because this represents winning trades over time. Profits are outweighing losses. The steeper the slope the better because that means your money is growing rapidly.

Figure 7.1 two sample equity curves.

upfrending. equity..

downtrending equity

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Take a look to see how smooth this line is. How about the zigzags in the line? Are there any that represent a fairly sizable loss or series of losing trades? If the opposite is occurring and the equity line is pointing downward, you should be very concerned. This situation represents more losses over time than winners or big losses that cannot be overcome by the winning trades. This situation is what every trader tries to avoid. If this situation is happening, you need to analyze your trading or system to determine what is causing the losses. Are you following your plan? Has the market changed? If you are trading a trend-following system and now the markets are trend-less and choppy, this could cause losses as you get whipsawed. A sideways equity chart represents profits and losses that generally are equal over time. The losses and profits cancel out. In this situation, equity is trapped between two levels, for example, $10,000 and $12,000. If this is the scenario, you need to analyze why losses occur after your winning trades. Perhaps the risk-to-reward ratios should be higher.

Equity Line Techniques 1

Trendlines

The same analytical techniques applied to markets can also be applied to equity charts. Trendlines connect important highs and lows to project the anticipated