Money Management
Every CFD trader, Forex trader or Index futures trader (or share investor) should take time to understand Money Management. It is an aspect of short-term trading that will help you deal with the inevitable times when losing streaks occur and can make the difference between staying in the game and losing your share trading bank.
Any trader can tell you from experience that losses are an inevitable part of share trading. Even a 60% success rate in picking winners Vs losers means that 4 out of 10 of your trades will end up with a cash drawdown. There is also a chance that these 4 losing trades could occur consecutively. However, what if the losing streak becomes 8 losing trades in a row?
Your trading bank will suffer even though the trading historically demonstrates a 60% win rate. As we have seen many times in the past there are some great technical trade entries, which due to market mechanics may not provide the desired result.
So, as traders, how do we drag the odds more in our favour even more so that our trading accounts will be protected when we hit a losing patch?
As we have covered in previous lessons there are capital management techniques for use with CFD trading. There is also a technique that utilises a moving average
Your Own Moving Average
On your trading bank; basically plotting your trading account equity against its own moving average. This allows you to base the trade size on the relationship of your equity line with its moving average.
Many auto-trade systems use this technique. it will cause all trading with real capital to cease when a particular loss threshold is reached. All trade suggestions are then 'paper traded'. The success/fail results of the paper trades added to the equity curve the same as live trades, however no cash is at risk until the moving average comes back into a positive relationship with the equity curve, indicating that the losing streak is over.
How does this work in practice?
If our trading account is worth $10,000 and the first trade is positive $100, then a point at $10,100 can be put on the chart and that forms the second point on the chart (the first being $10,000). The next trade may be a $200 gain, followed by a $150 loss, thus we begin to see a line forming representing our changing account equity.
Next we plot a moving average of the points on our equity curve. It doesn't matter if it is a simple moving average or an exponential moving average, but for demonstration purposes we will use a "simple" moving average. Once we have 15 points on our equity curve we can use a 15-period SMA and plot a point which is the average of them all. As our equity curve changes while we trade, we continue to update the SMA with each trade we take and this will begin to form another line moving along with our equity.
By monitoring the relationship between the equity curve and the SMA, we can make trading decisions for future trades. Therefore if our equity curve dips below the SMA, we may consider using a paper trade for the subsequent trade. The result of that simulated trade is then recorded as if it were live and the SMA is recalculated. Trading would continue in simulation mode until the equity curve crosses back over the SMA and heads up.
Once the concept is mastered more complicated techniques can be utilised using this method as a base, such as deciding the size of the trade position in relation to the equity curve's Simple moving average. But in its simplest form, this technique has the ability to stop you from trading live as you enter losing streaks and then recognize when the winning streaks happening. You will obviously miss a few winning trades using this technique but in theory it should keep you out of more losing trades than winning ones.
