Many people, when they first think about trading, immediately consider technical indicators, candlestick patterns, or moving averages? The direction of the trend, bullish or bearish? How can one perfectly buy at the low and sell at the high? Where can one find a profitable trading system? And so on.

However, few people mention the matter of "funds management."

There was a time when no matter how I traded, I was losing. I was very puzzled at the time. I had a trading system, I had read hundreds of books, and I could discuss the ways of trading with my eyes closed, yet I still couldn't make a profit.

Later, after receiving some guidance, I found the problem in my own trading records. Solving the issue of funds management broke the last curse of my trading losses. Since then, I have truly entered the realm of profitability.

So today's article, I will share what I believe to be the most important thing in trading with everyone, hoping it can be helpful to you.

1. What is funds management?

Trading is like running a company. You need to understand your financial strength and your risk tolerance in order to decide how much leverage you can add and how to manage your risk control effectively.

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The debt issue that Evergrande encountered recently was essentially due to too much leverage, leading to a break in the capital chain. They were involved in something too big, and someone stepped in to bail them out. But as a small trader, if we encounter such a situation, our end result would be a margin call.

Whether it's futures or foreign exchange, both markets come with high leverage. If we do not establish reasonable funds management rules and have poor self-control, it is very likely that we will lose more than we earn in the market, or even suffer consecutive margin calls.

So, to put it simply, funds management is about two key points:(1) How to Minimize Losses (Risk Control)

(2) How to Maximize Profits (Profit Allocation)

That is, when trading is in adversity, strictly control the amount of losses to ensure the safety of the account, with no risk of margin calls, and first survive; then, when trading is in favorable conditions, allocate positions reasonably to gain more profits.

The specific operations are as follows:

(1) What position should be used for each trade? How much money should be stopped when losing? How much money should be earned when profitable to exit?

(2) The overall drawdown risk control rules of the trading account, while ensuring the overall risk of the account is controllable, pursue the maximum profit.

2. How did I realize the importance of capital management?

Around the third year of my trading, I gradually established my own trading system. The success rate of the trading system at that time was quite good, but the account kept losing money, which I couldn't figure out.

Later, I started to record every trade of mine and found that I was trading as if it were a joke, with different positions for each trade, completely based on the mood of the moment.

For example, one time, I made profits on two trades in the morning, and there was some profit in the account, so I started to increase the position in the afternoon, thinking that even if I lost, it would only be a return of profits, not a loss of principal, and if I was right, I could make a big profit.The result was that the position was too heavy, and I quickly went from a small profit to a small loss. I immediately became unwilling to accept the loss, thinking that at least I had to make back the money to break even, right? But the market was against me at that time, and I experienced consecutive heavy position stop losses, which directly wiped out 35% of my account.

My mentality collapsed at that moment, and I went all-in against the trend, thinking that as long as there was a slight pullback, I would recover my capital. But the market didn't stop at all, and within 5 minutes, my account with ten thousand US dollars was blown out. It was very hard to earn ten thousand US dollars, but it only took a few minutes to lose it all.

So, my trading system at that time had no rules for money management. The overall success rate was high, but the profit-to-loss ratio was very poor, which led to continuous trading losses.

Later, in order to find the reasons for the losses, I started to keep trading records, which was also the most important turning point in my trading.

In the trading records, I found several points:

(1) My positions were always fluctuating between light and heavy.

(2) My trading outcomes were always big losses with small profits.

(3) Emotions had a particularly significant impact on trading results. Every heavy position did not bring significant profits but instead led to significant losses; whereas light positions tended to have better outcomes.

(4) The results of the trading system are distributed probabilistically. Given a profitable advantage in both success rate and profit-to-loss ratio, strict money management will definitely lead to profitability.

In fact, this is a particularly simple math problem, but it took me several months of losses to understand it.In subsequent transactions, I established rules for capital management, using a standard proportion of funds in each trade, thoroughly leveraging the success rate and profit-to-loss ratio advantages of the trading system, and gradually achieving profitability in trading. Additionally, with a fixed capital ratio, the trading mentality improved, and the issue of large losses and small profits in trading was resolved, making the trading process smoother.

Here is a suggestion for everyone:

If your trading is incurring losses, I suggest pulling out all your past trading records and conducting a data analysis. Then, try to standardize your previous random positions, and you will likely find that the profit and loss performance will be much better than your current loss situation. This indicates that your capital management in trading is not well done, so let's focus on improving capital management.

Next, I will discuss the two most common methods for capital management in practical situations.

3. Two Methods of Capital Management

There are two most common methods for capital management:

(1) Using a fixed stop-loss amount method

(2) Using a fixed position size methodThese two methods primarily address the two most mainstream profit models of trading systems.

Method 1: Using a fixed stop-loss amount to counteract trading systems that gain a profit advantage through "relying on success rate + risk-reward ratio."

Such trading systems typically have a fixed take-profit point, for example, all orders are set with a 2:1 risk-reward ratio. As long as the trading system's success rate is higher than 33%, it can achieve a balance in trading profits and losses. Once it exceeds 33%, the trading system can be profitable. However, there is a significant prerequisite for profit: the use of a fixed stop-loss amount in capital management for each trade.

How is this done specifically? Let me illustrate with an example.

For instance, consider a $10,000 account where each trade uses 1% of the principal as a stop-loss ($10,000 x 1% = $100). The risk-reward ratio is set at 2:1, meaning for every loss of $100, there is a profit of $200 when correct. As long as the trading system's success rate is higher than 33%, and the trading system is consistently executed, the overall trading will definitely be profitable.

At this point, traders may wonder, since the stop-loss space varies each time, how can we ensure that the stop-loss amount is $100 each time? This requires us to adjust the position size for each opening position based on the stop-loss space to ensure that the stop-loss amount is fixed.

The position size calculation formula is: Stop-loss amount / Stop-loss space = Position size.

This trading method involves measuring the stop-loss space before each opening position and calculating the position size in advance based on the stop-loss space.

Points to note:

1: What percentage of the position is appropriate?In the example just given, using 1% of the principal as a fixed stop-loss amount, some traders may ask themselves in practice, how to determine what percentage is appropriate? There are two key points.

A: Determine based on the number of errors when the trading system deteriorates.

The more times there are, the smaller the fixed capital ratio that should be used; otherwise, the account will suffer severe losses during system deterioration in practice, affecting trading. If there are fewer instances, a heavier position can be used.

B: Set according to the trader's risk preference.

Some people are timid, panic at small losses, become fearful, and lack execution power, so they should use a smaller position; on the contrary, some people have a good mentality, can maintain a healthy mindset even with large account drawdowns, and still have execution power, so they can use a larger position.

2: In practice, there will inevitably be positions that cannot be evenly divided, and there is a certain flexibility in practical operations.

For example, in the example above, 100/155=0.6451, in practice, you can round the position to the nearest whole number, and in this case, I used 0.64 lots.

This method of capital management is also the method I use in my courses. Interested friends can also go directly to my public account (Eight-Digit Garden) to see it. I won't elaborate further here.

The second method: Using a fixed position approach to deal with trend-following trading strategies.

This type of trading system uses a passive take-profit exit strategy, which is a trend-following trade that allows profits to run. It generally uses technical indicators to follow the trend, such as moving averages, trend lines, inflection points, and other technical indicators. As long as the trend does not reverse, the position is held continuously.The advantage of a strategy-based profit is that it incurs some losses during periods of volatility, but once a trend emerges, it captures that trend to gain more profit space. Essentially, this type of strategy profit relies on points to win. For example, during volatility, a loss of 3,000 points occurs, but a significant trend is caught, resulting in a 5,000-point gain, leading to an overall profit of 2,000 points.

This requires the use of a fixed position for each trade; if the position is random, losses will occur. For instance, if the loss is at a position of 1 lot, the loss would be 3,000 points x 1 lot = $3,000 USD. When profiting, if the position is 0.5 lots, the profit would be 5,000 points x 0.5 lots = $2,500 USD.

The calculation of the loss is $3,000 - $2,500 = a loss of $500. Due to the unreasonable use of position size, even with more profitable points, the outcome can still be a loss.

Note: Since in the overall trend of the financial market, trend-based scenarios are much rarer than volatile scenarios, with a general ratio of 3:7, the success rate of trend-based trading systems is usually below 30%.

If position size is adjusted at will, and heavy positions are randomly allocated to volatile scenarios, the probability of incurring losses is higher. For trend-based trading strategies, using random position sizes can easily lead to losses.

How to determine the position size specifically?

A: Based on the trading time frame.

For example, when entering on a break, the stop-loss space is larger at the 1-hour level than at the 5-minute level. Therefore, the position size at the 1-hour level should be smaller than at the 5-minute level.

B: Based on the trading system's frequency and the value of decay.

For instance, when using EMA90 and EMA180, the short-term moving averages change quickly, leading to more signals and frequent trading in volatile scenarios, which requires running with a lower position size. Long-term moving averages react slowly and change less frequently, resulting in a lower trading frequency, and thus the position size can be appropriately increased.C: Determined based on the volatility of different varieties.

For instance, the Euro against the US Dollar fluctuates within 1000 pips daily, while gold often experiences movements of over 2000 pips. Therefore, a heavier position can be used for the Euro against the US Dollar compared to gold.

Here are some reference position values for commonly traded varieties.

For mainstream varieties such as the Euro against the US Dollar, the British Pound against the US Dollar, and the US Dollar against the Japanese Yen, for an account trading with 10,000 USD, the fixed position for the 1-hour timeframe should not exceed 0.5 lots.

For more volatile varieties such as gold, crude oil, and the British Pound against the Japanese Yen, for an account trading with 10,000 USD, the fixed position for the 1-hour timeframe should not exceed 0.3 lots.

4. Special considerations for money management

(1) The position usage for small capital can be more aggressive.

An account with 2000 USD and another with 20,000 USD, both applying a money management rule of using 1% of the principal for a single stop loss, will both experience a maximum capital drawdown of 30%.

The absolute drawdown for the 2000 USD account is 600 USD, while for the 20,000 USD account, it is 6000 USD. Although the percentage is the same, the psychological impact on the trader is different between 600 and 6000, so those with smaller capital can appropriately increase their positions.

(2) Position scaling should also be included in the rules of money management.Trend traders enjoy adding to their positions during trades, which can yield substantial profits in trending markets. However, adding to positions also carries the risk of losses, so there are two key points to consider when doing so.

First point: Establish and strictly follow a capital management rule for each addition to the position.

Second point: Whenever possible, use a pyramiding strategy when the position is already in profit, which means increasing the position with smaller amounts as the market moves in your favor. This way, if the market retraces, the overall profit given back will be relatively small, which is conducive to the execution of trades.

These are the methods for capital management in actual trading, and I hope they are helpful to everyone.