Money Management. The most important, most neglected aspect of automated trading.

It is funny how people in forums and people who program expert advisors in general seem to address the problem of finding a profitable system and making it profitable. It seems that most of the time, most of their time and testing is spent on evaluating the entry and exit strategies of the trading strategy. People seem to think that the actual money in the forex market is gained by getting perfect entries and exits all the time, or most of the time.

I have seen people in forums go around for months trying to modify their strategies to make them profitable, they will add filters, add indicators, change the rules, optimize the variables, the indicator periods, add volatility filter, to sum it up, they will do everything they can to further perfect their entry and exit strategies. To further worsen things, most of their efforts are concentrated in the entry to the market, which is the most trivial and unimportant part of forex trading systems (see more on this on my ebook).

I have found out that the most important part of a trading system is not the entry or the exit of the strategy, but the money management. What ? Many people will just be awed by this fact as this is hardly even spoke of and people always neglect its importance when they program an automated trading system. When people buy an EA, they don’t really care about how the EA actually manages their money, which is, as I have already said, the most important aspect of the system.

Usually people will use a money management system that just trades a fixed percentage of equity or a fixed lot size. They couldn’t do any worse. Trading like this only relies on your account balance, not on the market and any money management system that makes sense, gauges the market to know how much money should be invested. For example, would you invest as much on the stock market now as you did last year ? The answer is NO. Why is this the answer ? Because how much you trade depends on how the market is behaving, is it a “good time” or a “bad time” ? Your money management must depend on both your account balance and market behavior, this is the way professional traders manage their trades. They don’t trade X percentage or a fixed lot size, those money management strategies are just naive and precarious.

As I have shown previously, I have been able to take several systems that showed no profit at all and simply by removing all the additional filters that had been added and adding a money management system that made sense I was able to make them profitable. This is something you should NEVER neglect and something in which your attention should be focused. A money management that makes sense will make a system that makes sense and that trades according to how the market actually moves.

If you would like to learn more about automated trading systems, how I evaluate them, test them and how you to can build and program your own long term profitable automated trading strategy please consider buying my ebook on automated trading or subscribing to my weekly newsletter to receive updates and check the live and demo accounts I am running with several expert advisors. I hope you enjoyed the article !

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2 Responses to “Money Management. The most important, most neglected aspect of automated trading.”

  1. Jim says:

    Hi,

    Can you define the variables that should be taken into account when developing a good money management system ?

    What are the best books related to the subject?

    Jim

  2. Daniel says:

    Hi Jim,

    A good money management system, as I mentioned, should take into account three things : Equity, Risk and the Market. The way in which the market is taken into account can vary and no fixed variable is "the best" as each system may benefit from a different adaptation to the market. However, the main characteristic of the market that must be taken into account is volatility as this is what changes the range of market movements. Volatility can be taken into account using indicators (like the ATR) or by using a multiple of previous bar low/high, etc. As you see, the possibilities become almost endless. Both lot sizes traded and stoploss and takeprofit must be adapted towards these variables. If you are more interested on this subject I will be publishing an article next month on Currency Trader magazine about this.

    Regarding book, the best one for learning money management would be :

    - "The mathematics of money management: risk analysis techniques for traders" by Ralph Vince, who shows a very comprehensive guide to money management through mathematical analysis.

    I believe that many other books have a pretty poor approach to money management and I truly believe that traders still need a true guide to complex money management that uses modern tools. I hope this helps !

    Best Regards,

    Daniel

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