Investing your precious money in the stock market is not only about wealth management alone. It is also about money management. Money management in the traditional sense basically means being able to manage your money efficiently.
However, in the context of the stock market, it means something else entirely. Being aware of money management rules in trading can make you a better trader. So then, what is money management and what are the strategies that you can implement? Continue reading to find out.
Money management, in the context of trading, basically means implementing techniques and strategies to limit risk while simultaneously increasing the reward. To achieve this goal, traders usually tweak the trading position size by either increasing it or decreasing it.
If you’ve just started to invest in the stock market, money management is something that you should definitely know. Here’s some more information regarding the strategies that you can implement to reduce your risk and increase reward.
There are many money management rules in trading that traders can implement. Let’s take a look at 5 of the most popular ones.
1. The 2% rule
According to this money management rule, traders wanting to invest in the stock market shouldn’t take a risk of more than 2% of their total account balance for every trade. This is a very conservative approach that’s perfect for beginners and traders not wanting to take high risks.
2. Fixed fractional method
As per the fixed fractional method, you would have to first buy a stock for a particular amount of money, say Rs. 10,000. Once the value of the stock goes up and reaches Rs. 20,000, which is double your initial investment, you can then purchase more shares of the same company. This will help reduce the amount of risk that you undertake.
3. Fixed ratio method
The fixed ratio method is very similar to the fixed fractional method. According to this, you will have to first purchase a stock. Once the stock makes a particular preset amount of profit, you can then purchase more shares. And then again, once the stock makes double the preset amount of profit, you may then purchase even more shares. This goes on and on till the time you decide to stop.
4. Optimal F method
The optimal F method relies on your past performance to establish your position size. All that you have to do is take a look at all the trades that you’ve made profits on. Then, come up with an average position size. This can be your baseline position size for all of your future trades.
5. Secure F method
The secure F method is one of the most refined money management rules in trading. An enhanced version of the optimal F method, the secure F method involves determining the position size that gave you the maximum amount of returns on all your past trades. Once the position size is determined, it is used on all future trades.
Now that you know what the 5 most important money management rules in trading are, the next time you invest in the stock market, make sure to use one of them. If you don’t already have an online demat account, but you wish to open one, visit the website of Motilal Oswal. You can open an online trading and demat account for free within just a few minutes.
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