Smart money management doesn’t just involve risking an appropriate amount on every trade (covered in the risk management section), it also involves managing a winning trade from start to finish. This is an important part of any good trading methodology that is often overlooked by beginning and expert traders alike.
“What do I do after I enter a trade and it begins to make money?”, is a question that is frequently asked by my traders
You hear so-called experts often making general comments such as “Don’t let a winning trade turn into a loss,” or “You’ll never go broke taking a profit.” These tidbits belong in the same trash can as “The trend is your friend” and other similar remarks. This general pieces of advice can do more harm than good because of their nature – THEY ARE TOO GENERAL!!!
A beginning trader cannot be left filling in the blanks. Everything must be defined. That is why a complete trading strategy must include specifically how winning trades will be managed until the position is closed.
The basic diagram below was provided to illustrate, in a funny way, what typically happens to traders that don’t have a smart trade management plan in place. I have included the trader’s thoughts (in blue) on the diagram as the trade progresses (in this example, I assumed that the trader is not completely clueless and at least has a stop loss in place. In reality, if the trader did not use a stop loss, it could have gotten a lot nastier and funnier).
Even though the example about is very basic, it does illustrate the importance of protecting existing profits by raising your stops. When the trade became profitable, instead of having left the stop at 1% below the initial entry point, the trader should have raised the stop.
The stops on different portions of the entire position could have been set at different logical points; for example, a certain amount above the initial entry point, below the point corresponding to thought number 4, below the point corresponding to thought number 5, and so on and so forth. Even though I am oversimplifying the management of these stop losses, this example demonstrates the importance of using a logical money management technique to handle winning trades.
Since one of the goals of every day trader should be to protect his trading capital, protecting profits becomes just as important as limiting losses. If you think about it, protecting profits is a way to limit losses as well. When a trader is in a winning trade, the amount of unrealized profit becomes part of the total equity of his account. Consequently, protecting profits through smart money management is equivalent to conserving the value of the trading account.
Smart money management should be a part of every trading strategy and it is something that I really stress all the time to my traders.
Read more about the importance of using a well-defined day trading strategy.