Money & Risk Management in trading

May 03, 2020
Alok Kumar
Money & Risk Management in trading

What Is Money Management?

Money management is the process of budgeting, saving, investing, spending or otherwise overseeing the capital usage of an individual or group. The predominant use of the phrase in financial markets is that of an investment professional making investment decisions for large pools of funds, such as mutual funds or pension plans. Money management can also be referred to more narrowly as “investment management” and “portfolio management.”

The Basics of Money Management

Money management is a broad term that involves and incorporates services and solutions across the entire investment industry. In the market, consumers have access to a wide range of resources and applications that allow them to individually manage nearly every aspect of their personal finances. As investors increase their net worth they also often seek the services of financial advisors for professional money management. Financial advisors are typically associated with private banking and brokerage services, offering support for holistic money management plans that can involve estate planning, retirement and more.

Correctly managing your capital and risk exposure is essential when trading options. While risk is essentially unavoidable with any form of investment, your exposure to risk doesn’t have to be a problem. The key is to manage the risk funds effectively; always ensure that you are comfortable with the level of risk being taken and that you aren’t exposing yourself to unsustainable losses.

The same concepts can be applied when managing your money too. You should be trading using capital that you can afford to lose; avoid overstretching yourself. As effective risk and money management is absolutely crucial to successful options trading, it’s a subject that you really need to understand. Now we’ll look at some of the methods you can, and should, use for managing your risk exposure and controlling your budget.

  • Using Your Trading Plan
  • Managing Risk with Options Spreads
  • Managing Risk through Diversification
  • Managing Risk using Options Orders
  • Money Management & Position Sizing

Using Your Trading Plan

It’s very important to have a detailed trading plan that lays out guidelines and parameters for your trading activities. One of the practical uses of such a plan is to help you manage your money and your risk exposure. Your plan should include details of what level of risk you are comfortable with and the amount of capital you have to use.

By following your plan and only using money that you have specifically allocated for options trading, you can avoid one of the biggest mistakes that investors and traders make: using “scared” money.

When you are trading with money that you either can’t afford to lose or should have set aside for other purposes, you are far less likely to make rational decisions in your trades. While it’s difficult to completely remove the emotion involved with options trading, you really want to be as focused as possible on what you are doing and why.

Once emotion takes over, you potentially start to lose your focus and are liable to behave irrationally. It could possibly cause you to chase losses from previous trades gone bad, for example, or making transactions that you wouldn’t usually make. If you follow your plan, and stick to using your investment capital then you should stand a much better chance of keeping your emotions under control.

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