STEPS IN THE MONEY MANAGEMENT PROCESS.
In our daily life we struggle to earn money. I true that we always want to earn money but management process its poor that’s why the money we earn do not full fill our needs. Lets take an example of a trader. A traders in online or not just trading but management process its poor. In reality I believe if you are a trader you wants to earn more money by doing your business.
The first of all the trader must decide whether or not to proceed with the signal.This become a serious problem when two or more commodities are vying for limited funds in the account.
Next, for every sign accepted, the trader must decide on the fraction of the trading capital that he or she is willing to risk. The goal is to maximize profits while protecting the bankroll against undue loss and overexposure, to ensure participation in future major moves. An obvious choice is to risk a fixed dollar amount every time. For each signal pursued, the trader must determine the price that unequivocally confirms that the trade is not measuring up to expectations. This price is known as the stop-loss price, or simply the stop price. The dollar value of the difference between the entry price and the stop price defines the maximum permissible risk per contract. Now the following are the best money management process.
Next, for every sign accepted, the trader must decide on the fraction of the trading capital that he or she is willing to risk. The goal is to maximize profits while protecting the bankroll against undue loss and overexposure, to ensure participation in future major moves. An obvious choice is to risk a fixed dollar amount every time. For each signal pursued, the trader must determine the price that unequivocally confirms that the trade is not measuring up to expectations. This price is known as the stop-loss price, or simply the stop price. The dollar value of the difference between the entry price and the stop price defines the maximum permissible risk per contract. Now the following are the best money management process.
1.RANKING OF AVAILABLE OPPORTUNITIES
Its important to know that currently, there are over 50 different futures contracts traded, making it difficult to concentrate on all commodities. Superimpose the practical constraint of limited funds, and selection assumes special significance. Ranking of competing opportunities against an objective yardstick of desirability seeks to alleviate the problem of virtually unlimited opportunities competing for limited funds. The desirability of a trade is measured in terms of expected profits, risks associated with earning targeted profits, and investment required to initiate the trade. As a trader its important to know that the increasing expected profit for a given level of risk, the more desirable the trade. Similarly, the decrease of the investment needed to initiate a trade, the more desirable the trade.
2.CONTROLLING OVERALL EXPOSURE
Overall exposure is the fraction of total capital that is risked across all trading opportunities. For instance Risking 100 percent of the balance in the account could be ruinous if every single trade ends up a loser. At the other extreme, risking only 1 percent of capital mitigates the risk of bankruptcy, but the resulting profits are likely to be inconsequential. The fraction of capital to be exposed to trading is dependent upon the returns expected to accrue from a portfolio of commodities. In general, the higher the expected returns, the greater the recommended level of exposure.
The optimal exposure fraction would maximize the overall expected profit. In order to facilitate the analysis, data on completed trade returns may be used as a proxy for expected returns.Another relevant factor is the correlation between commodity returns.Two commodities are said to be positively correlated if a change in one is accompanied by a similar change in the other.
Conversely, two commodities are negatively correlated if a change in one is accompanied by an opposite change in the other. The strength of the correlation depends on the magnitude of the relative changes in the two commodities.
In general, the greater the positive correlation across commodities in a portfolio, the lower the theoretically safe overall exposure level. This safeguards against multiple losses on positively correlated commodities. By the same logic, the greater the negative correlation between commodities in a portfolio, the higher the recommended overall optimal exposure..
3.ALLOCATING RISK CAPITAL
When the trader has decided that, the total amount of capital to be risked to trading, the next step is to allocate this amount across competing trades. The easiest solution is to allocate an equal amount of risk capital to each commodity traded. This simplifying approach is particularly helpful when the trader is unable to estimate the reward and risk potential of a trade. However, the implicit assumption here is that all trades represent equally good investment opportunities.
A trader who is uncomfortable with this assumption might pursue an allocation procedure that identifies trade potential differences and translates these differences into corresponding differences in exposure or risk capital allocation. The higher the probability of success, and the higher the payoff ratio, the greater is the fraction that could justifiably be exposed to the trade in question.
4.ASSESSING THE MAXIMUM PERMISSIBLE LOSS ON A TRADE
Risk in trading futures stems from the lack of perfect foresight. Unanticipated adverse price swings are obstacles to trading; controlling the consequences of such adverse swings is the hallmark of a successful speculator. Inability or unwillingness to control losses can lead to ruin.Before initiating a trade, a trader should decide on the price action which would conclusively indicate that he or she is on the wrong side of the market. A trader who trades off a mechanical system would calculate the protective stop-loss price dictated by the system. If the trader is strictly a chartist, relying on chart patterns to make trading decisions, he or she must determine in advance the precise point at which the trade is not going the desired way.
It is always tempting to ignore risk by concentrating exclusively on reward, but a trader should not succumb to this temptation. There are no guarantees in futures trading, and a trading strategy based on hope rather than realism is apt to fail.
5.THE RISK EQUATION
Trade-specific risk is the product of the permissible dollar risk per contract multiplied by the number of contracts of the commodity to be traded. Overall trade exposure is the aggregation of trade-specific risk across all commodities traded concurrently. Overall exposure must be balanced by the trader’s ability to lose and willingness to accept a loss. Essentially, each trader faces the following identity:
However, the willingness to assume risk is influenced by the trader’s comfort level for absorbing the “pain” associated with losses. An extremely risk-averse person may be unwilling to assume any risk, even though holding the requisite funds. At the other extreme, a risk lover may be willing to assume risks well beyond the available means.
For the purposes of discussion in this book, we will assume that a trader’s willingness to assume risk is backed by the funds in the account. Our trader expects not to lose on a trade, but he or she is willing to accept a small loss, should one become inevitable.
6.BALANCING THE RISK EQUATION
As the trader’s ability to lose and willingness to assume risk is determined largely by the availability of capital and the trader’s attitudes toward risk, this side of the risk equation is unique to the trader who alone can define the overall exposure level with which he or she is truly comfortable. Having made this determination, he or she must balance this desired exposure level with the overall exposure associated with the trade or trades under consideration.
Since exposure is the product of the dollar risk per contract and the number of contracts traded, a downward adjustment is necessary in either or both variables. However, manipulating the dollar risk per contract to an artificially low figure simply to suit one’s pocketbook or threshold of pain is ill-advised, and tinkering with one’s own estimate of what constitutes the permissible risk on a trade is an exercise in self-deception, which can lead to needless losses.
Therefore, the trader must necessarily adjust the number of contracts to be traded so as to bring the total risk in line with his or her ability and willingness to assume risk. If the capital risked to a trade is $1000, and the permissible risk per contract is $500, the trader would want to trade two contracts, margin considerations permitting. If the permissible risk per contract is
$1000, the trader would want to trade only one contract.