Quote"Ruin is the risk you should be concerned with the most. It can come like a thief in the night and steal everything
if you aren’t watching carefully"
<Key Points>
Money management comes from gambling theory. Money management is the art of keeping your risk of ruin at an acceptable level while maximizing your profit potential by choosing an appropriate number of shares or contracts to trade.
I believe that money management is more art than science, or perhaps more like religion than art. There are no right answers.
Here is what I believe accounts for a trader’s lack of success in trading commodities:
• No plan: Many traders base their trades on hunches, rumor, guesses, and the belief that they know something about the future direction of prices.
• Too much risk: Many otherwise excellent traders have been ruined because they incurred too much risk. I’m not talking about 50 percent or 100 percent more risk than is prudent. I have seen traders who trade at a level that is 5 or 10 times more than I consider prudent even for aggressive trading.
• Unrealistic expectations: Many new traders trade with too much risk because they have unrealistic expectations about how much they can earn and what sorts of returns they can achieve. This is often also the reason new traders believe they can start trading on the basis of fundamental data; they believe they are smart enough to “beat” the market with little or no training and very little information.
<Turtle Money Management Means Staying in the Game>
For traders, death comes in two forms: a slow painful death that causes traders to stop out of anguish and frustration and a spectacular rapid death we refer to as a blowup.
The uncertainty of the future is what makes trading so difficult, and people do not like uncertainty. Unfortunately, the reality is that the markets are unpredictable and the best you can hope for is a method that generally works over a relatively long period. For this reason, your trading methods should be designed as much as possible to reduce the uncertainty you can expect to encounter when trading.
<The N Factor>
As was mentioned earlier, Rich and Bill used an innovative method for determining the position size for each market on the basis of the amount that market moved up and down each day in constant dollar terms. They determined the number of contracts for each market that would cause them all to move up and down approximately the same amount in dollar terms. Since the number of contracts we traded for each market was adjusted for this volatility measure, N, the daily fluctuations for any particular trade tended to be similar.
Some traders prefer to measure risk in terms of the distance between the price at which one will exit a trade and the price at which that trade was entered. That is only one way of considering risk. In October 1987, it did not matter where our stops had been.
The market gapped through our stops overnight.
If I had been using a method that relied only on the distance between entry and stops, I would have lost four times as much as the typical Turtle on that day because I used a stop that was one quarter the size. I used a 1⁄2-ATR stop, whereas most Turtles used a 2-ATR stop. Thus, if I had been using a method that sized purely on the distance to the stop, my calculations would have resulted in a position that was four times larger than that of the typical Turtle.