A Trader’s Money Management System: How to Ensure Profit and Avoid the Risk of Ruin

Thank you to John T. Morris for buying “A Trader’s Money Management System” book and for reading it. And, though his review was less than glowing, I appreciate his comments here on Amazon.com because it opens up a valuable dialogue for traders about “effective” money management.

In response to his comments, let’s just say I’m the first to admire the work of Douglas, Elder and Tharp — and encourage anyone not familiar with their work to study them. My concern for Morris is that he makes no mention of Nauzer Balsara or Ralph Vince — arguably the two greatest mathematicians in the field of trading. These men are mentioned in my book because their timeless concepts (both wrote books over 15 years ago) are the basis for truly “effective” money management.

With that said, many will agree that Balsara and Vince, while they are pure genius, can be at times difficult to comprehend for the new trader — and even for some very seasoned traders. What “A Trader’s Money Management System” does for the reader, is to make some of these complex concepts — like using the risk-of-ruin tables and optimal f formulas — easy to understand and instantly implement.

Apparently my simplicity in the book has worked since Morris says in his review that “…I do give this book two stars rather than one because it does contain some ideas that I have never run across before in my study of trading: The Risk of Ruin concept plus optimal percentage formula to determine the amount of equity capital to be risked on any one trade…”.

If he has gained that insight from the book, then he is one step closer to developing more “effective” money management. The next big step for him would be to realize that there is no “magic percent” to risk on each trade. The 2% figure is purely an example and a frame of reference for the reader and that is why there is an “Important Note” stated when ever the 2% figure is mentioned. The important note directs the reader to Chapter 9 so that they can use the risk of ruin tables and optimal f formulas to calculate the exact amount that should be risked on each trade.

When Morris states that “…except in very exceptional cases, 2% is way too much to risk on a trade and that it should be more like half at most…” he is not basing his analysis on any mathematical probabilities. Instead, it’s more of a hunch, since he’s taking numbers out of a hat from interviews in the Market Wizards book. He doesn’t know what the pay off ratios or win ratios for the traders interviewed were.

By looking at page number 79 in “A Trader’s Money Management System” you’ll see that my recommendation for a trader producing a win ratio of 35% (meaning you are winning only 35% of your trades) and a payoff ratio of 2 to 1 (meaning for every dollar you lose you earn 2 dollars) — they should be risking only 1% . Where as on the same page of the book you’ll see that if you have a win ratio of 50% and a payoff ratio of 3 to 1 you would in fact be able to risk 10%.

Why can one trader risk only 1% and another risk as much as 10%? It is simple, from a mathematical probability, their historical performance warrants — less risk — OR — more risk — depending on how well they trade.

I’ve been working with traders for over ten years and have to say that my passion is trading and education. Hopefully this response to John T. Morris will give other traders, if not Morris himself, some insight into effective ways to structure their risk — depending on what their current trading results are telling them through their win ratio and payoff ratio.

Rating: 5 / 5

This one’s a brand new book to add to your collection of Ralph Vince and Nauzer Balsara. Difference, though, is that this book really simpllifies the essentials and makes it easy for even the beginner to understand the sometimes complex money management formulas that truly are essential to trading success. I’ve got the other books too — but this is the one that helped me effectively and profitably implement the formulas to calculate what percent of risk to take on each of my trades so that I’m not risking too much (which has exposed me to risk of ruin in the past) and then again — McDowell’s formulas help me not risk too little so that I’m not maximizing my return. The formulas are all based on your performance statistics at any given moment (which will be different during drawdown VS a winning streak) and they are basic algebra — so you don’t need to be a mathematical expert to use them. The other really valuable tool that has helped me is the record keeping forms that come with the book. Now I’m caputuring the data I need on each transaction and my analysis gives me the answers I need.
Rating: 5 / 5

Read this book before you lose your life savings or a portion thereof. I would venture to guess that most “non professionals” play in markets without a plan or system. It may be true that more people lose money in the market than make money in the market, especially in 2008. Well, if you fall into this category you need to read and use this book before you make another trade. Money management discipline is more important than stock picking!

This book is an easy read. It will, in a clear and concise manner, guide you to create your trading system for money management (“preservation”). Learn your strengths and identify your weaknesses. Understand your risk psychology and how to develop a “Traders Mindset” that fits you. Entry rules, stop-loss exits, risk-of-ruin tables, tracking systems and risk management rules, it is all here. It’s well laid out and worth the investment in your financial future. I am glad that I bought and am using this book. Highly recommended!

Rating: 4 / 5

I have been trying to learn more about stock trading, particularly how to maxamize my profits and minimize my loss. This book is helping me to make more intelligent decisions about how to manage an entry position and establish a plan for exit. The explanation of a Trader’s Mindset is helping me better manage my trading strategies.
Rating: 4 / 5

If you are serious about being a profitable stock trader then this book belongs on your top shelf. I have been trading stocks successfully for five years and have read over 100 books on the subject and put this in the top five for useful information. This book spells out each step very simply and clearly for money management,so that you can instantly know, step by step and formula by formula what you need to do so that risk is minimized and the probability of success is maximized.

The six types of risk to manage in trading are covered in detail:

1. Trade risk

2. Market risk

3. Margin risk

4. Liquidity risk

5. Overnight risk

6. Volatility risk

Your long term success will depend on your ability to control these variables to make your risk of ruin almost zero. “The markets are the ultimate university of finance and sometimes the tuition is on par with Harvard, Columbia, or Yale”.

This book will take you through exercises to identify your strengths and weaknesses as a trader and show you where improvement is needed. It will also give you questions to answer to grade yourself on where your personality is on the spectrum for taking on risk and also your level of discipline.

This book contains a wealth of useful work sheets that enable you to track your trading statistics daily, weekly, monthly, and yearly. You should have at least 25 trades for a system, then check the statistics for that sample. The book suggests the key stats will be: the win ratio, payoff ratio, commission ratio, largest winning trade, largest losing trade, average winning trade, average losing trade, largest % of draw down, average of draw down, total % of profit/loss. These stats are crucial in determining where adjustments need to be made for greater success. While and average amount of risk is 2% of equity on each trade, your amount of risk could be adjusted higher or lower based on your win rate.

If you are a fan of Alexander Elder’s work then this book will fit in great with his methods. There is no greater book on money and risk management on the market that I know of. Don’t go back in the market with out reading it and implementing the record keeping and risk control tactics it teaches.

Rating: 5 / 5