Money management does not contribute expectancy to a trading strategy – it determines the “half life” of a trading strategy, and that’s it. Money Management, in and of itself, doesn’t make you any money.
I will explain how this is the case by drawing an analogy between a trading strategy and a Formula 1 racing car.
Broadly speaking, there are three factors involved in making an F1 car go quickly round the racing track:
1. The Engine
An F1 car won’t go anywhere without an engine and petrol to fuel it. In the case of motor racing, a bigger engine can help you go faster round the track; this is not necessarily the case in the markets (unless you are swinging serious coin around). Certainly it is not a factor for the likes of (most) here – having more money wouldn’t make you trade “better”, but with none you can’t do anything. So having money is important.
2. Driver Talent
At any time the driver of an F1 car has 4 options presented to him: accelerate and turn left, accelerate and keep straight, accelerate and turn right or hit the brake. As with trading, there are 4 options on the table at any one time: Go Long, Hold, Go Short, and Close/Stay Flat. His skill as a driver is determined by choosing to do the right thing at the right time.
3. Aerodynamics
Aerodynamics are to an F1 car what Money Management is to a trading strategy. They keep it on the road. During an F1 season, the aerodynamics are changed according to the layout of the track; low aerodynamics mean the car can go very, very quickly – but will struggle to turn very tight corners (think Monza or Spa). High aerodynamics mean the top speed of the car is reduced, but it can turn on a 50 pence piece (a lá Monaco). And so it is with trading, bar one crucial factor – in trading, we can’t see the road ahead. We can put “low downforce” aerodynamics on our trading strategy and race ahead of the risk-free rate, and provided there are no sharp turns ahead we can make a packet (Spanish69 anyone?)- but if we find ourselves doing 220mph right before a hairpin, we’re ****ed; the aerodynamics of our car mean we can’t make the turn and we crash out of the race. On the other hand, we can compromise our top speed and set our car to “high downforce” aerodynamics, and compromise on our lap time – in order that we can make any sharp turns that come before us. We are never going to be quickest, in fact we often get lapped, but at least we are still racing.
The conclusion to draw is this: Trading strategy is what makes profits; Money management determines how long you can last vs. how much you make. It is not possible to consistently draw profits from the market if one doesn’t have a talented driver in the cockpit – a driver that makes a pretty good job of going long/short, holding or closing when he can’t see what lies ahead.
Money management can’t do that for you.
I will explain how this is the case by drawing an analogy between a trading strategy and a Formula 1 racing car.
Broadly speaking, there are three factors involved in making an F1 car go quickly round the racing track:
1. The Engine
An F1 car won’t go anywhere without an engine and petrol to fuel it. In the case of motor racing, a bigger engine can help you go faster round the track; this is not necessarily the case in the markets (unless you are swinging serious coin around). Certainly it is not a factor for the likes of (most) here – having more money wouldn’t make you trade “better”, but with none you can’t do anything. So having money is important.
2. Driver Talent
At any time the driver of an F1 car has 4 options presented to him: accelerate and turn left, accelerate and keep straight, accelerate and turn right or hit the brake. As with trading, there are 4 options on the table at any one time: Go Long, Hold, Go Short, and Close/Stay Flat. His skill as a driver is determined by choosing to do the right thing at the right time.
3. Aerodynamics
Aerodynamics are to an F1 car what Money Management is to a trading strategy. They keep it on the road. During an F1 season, the aerodynamics are changed according to the layout of the track; low aerodynamics mean the car can go very, very quickly – but will struggle to turn very tight corners (think Monza or Spa). High aerodynamics mean the top speed of the car is reduced, but it can turn on a 50 pence piece (a lá Monaco). And so it is with trading, bar one crucial factor – in trading, we can’t see the road ahead. We can put “low downforce” aerodynamics on our trading strategy and race ahead of the risk-free rate, and provided there are no sharp turns ahead we can make a packet (Spanish69 anyone?)- but if we find ourselves doing 220mph right before a hairpin, we’re ****ed; the aerodynamics of our car mean we can’t make the turn and we crash out of the race. On the other hand, we can compromise our top speed and set our car to “high downforce” aerodynamics, and compromise on our lap time – in order that we can make any sharp turns that come before us. We are never going to be quickest, in fact we often get lapped, but at least we are still racing.
The conclusion to draw is this: Trading strategy is what makes profits; Money management determines how long you can last vs. how much you make. It is not possible to consistently draw profits from the market if one doesn’t have a talented driver in the cockpit – a driver that makes a pretty good job of going long/short, holding or closing when he can’t see what lies ahead.
Money management can’t do that for you.
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