Use Sound Money Management When Trading Precious Metals

Do you know what is the most important aspect of successful metals trading? Is it identifying the trading opportunity? Is it proper entry into the market? Is it the trading "tools" you are using? Is it an exit strategy that is the most important aspect of trading? The answer is: None of the above (although an exit strategy is close).

The most important factor in successful metals trading is money management. One still has to be savvy at chart forecasting and-or fundamental analysis, but it's the money-management factor that will make or break a trader. The huge leverage involved with trading futures absolutely requires pinpoint money managing.

Over the years, I have listened to the best traders in the business talk about what makes them succeed in this challenging arena, and nearly every one emphasizes the importance of sound money management. A few years ago I attended a TAG (Technical Analysis Group) trader's conference in Las Vegas. One of the featured speakers stressed that becoming a successful trader should be more an act of survival in the early going than scoring winning trades.

Surviving in the market trading arena absolutely requires practicing sound money management. Even a rookie trader who starts out with a hot hand will eventually find that at least some trades are not going to go his way. And if he has not employed good money- management principles on those losing trades, he will likely have squandered his trading profits and his entire trading account.

Conversely, the novice trader who uses good, conservative money management techniques will be able to withstand some losses and be able to trade another day. The ability to take a loss and trade another day is the key to survival--and ultimate success-- in the markets trading arena.

Here's an important point to consider, regarding money management and successful trading: Most successful shorter-term traders will tell you that during the span of a year they have more losing trades than winning trades. Then why are they successful? It is because of good money management. Successful traders set tight stops to get out of losing positions quickly; and they let the winners ride out the trend. On the balance sheet, a few bigger winning trades will more than offset the more numerous smaller losers. Good money management allows for that to happen.

"Good money management" is a relative principle. A good money- management practice for one trader might not be a good money- management practice for another. Here's a real-life example: I had a fellow email me a while back, saying he was up $3,000 in a gold trade, and that his total trading account was $4,000. Although I don't provide specific trading advice to individuals, I told the trader that if I had only a $4,000 trading account and had racked up 3 grand in profits on one trade, I would seriously think about ringing the cash register on that trade and building up my account so that I could withstand those drawdowns and losers that will eventually occur. 

On the other hand, if a trader with a $30,000 account had a $3,000 winning gold trade, he may want to let the winner ride a little longer, as pocketing the profit would not nearly double his trading account, as it would the smaller-capitalized trader.

In other words, don't be a greedy trader. There's an old trading adage that says there is room for bulls and bears in the marketplace, but pigs get slaughtered.

Let me emphasize here there is nothing wrong with starting out with, or keeping, a smaller-capitalized trading account. But I strongly suggest that those smaller accounts use the very strictest of money management.

There are dozens of good futures and stock trading books available, and most spend at least an entire chapter on money management.

Here are just a few very general money-management guidelines:

  • For smaller-capitalized traders, don't commit more than one-third of your trading capital to one trade. For medium- and larger-capitalized traders, you should not commit more than 10% of your capital to one trade. The guideline here is, the larger your trading account, the smaller your commitment should be to one trade. In fact, some trading veterans suggest larger trading accounts should not commit more than 3-5% of their capital to one trade. Smaller-capitalized traders, by necessity, have to commit a larger percentage of their capital to one trade. However, these small-cap traders may want to trade options (buying them, not selling them), as risk is limited to the price paid for the option.
  • Use tight protective stops in all your trades. Cut your losses short and let the winners ride the trend.
  • Never, never, never add to a losing position.
  • Your risk-reward ratio in a futures trade should be at least two to one. In other words, if your risk of loss is $1,000, your profit potential should be at least $2,000.

I can't stress enough that survival in the trading arena (especially for beginners) should be your top priority.

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