Trading comes with risk. No matter what asset you’re trading, no matter how you plan to trade, there will always be the risk of losing capital. However, there are ways to dial down that risk. These strategies are called capital management or loss exposure strategies. Today, we’ll talk about what capital management is, the two most prominent types of traders, and the capital management strategies that tends to fit these traders best.
What Is Capital Management
Capital management is the process of ensuring that there’s not too much of your available capital at risk at any given time. Essentially, by reducing your exposure to loss, it’s impossible to lose all of your capital or even anywhere near all of your capital during any given trading session. So essentially, capital management is the foundation to building a solid trading strategy.
The Two Most Prominent Types Of Traders
While different traders will tend to use different strategies, everyone seems to fall into one of two main bucket categories. They include…
- Passive Traders – Passive traders are traders that are looking to make money in the market, but don’t want to take on too much risk. Therefore, their trading strategies tend to follow more passive guidelines as they are willing to reduce potential gains in an attempt to maintain a high level of capital.
- Aggressive Traders – Aggressive traders are traders that want to earn as much money as humanly possible; even if that means that they must take on a higher level of risk. While capital is important to these traders, their ultimate goal is to make large returns; and to do so, they must risk larger amounts of money.
The Two Key Capital Management Strategies The Every Trader Should Know
Capital management strategies involve ensuring that there is only a percentage of capital at risk at any given time. These strategies place limits on the amount of money that can be traded in any single trade as well as limits on the total amount of money that can be allotted to active trades at any given time. Here are the two best strategies for properly managing capital while trading…
Passive Trading Capital Management – The 5/15 Rule
The 5/15 rule is best for those that want to take a more passive approach when trading. This rule is based on percentages. The first number in the rule (5) is the percentage of capital that should be the maximum amount of money at risk during any single trade. The second number in the rule (15) is the percentage of capital that should be the maximum amount of money at risk across all trades at any given time.
Keeping that in mind, let’s say that you have $1,000 in total trading capital. Under the 5/15 rule, you would never risk more than $50 on any single trade nor would you ever risk more than $150 in active trading at any given time. Therefore, if you traded to the max, you would make 3 $50 trades. However, it is also OK to make 6 $25 trades, 2 $50 trades and 2 $25 trades, or any other combination that would cap out the total investment on a single trade at $50 and the total in active trades at $150.
Aggressive Trading Capital Management – The 10/30 Rule
The 10/30 rule works a lot like the 5/15 rule. The only difference is that the 10/30 rule is more aggressive; ultimately putting more capital at risk with the goal of generating higher returns. Therefore, under the 10/30 rule, traders would never risk more than 10% of their total capital on a single trade or more than 30% of their capital in overall active trades.
This means that using the $1,000 total capital example above, under the 10/30 rule, traders would cap investments on a single trade at $100 and would cap investments on all active trades at $300. This means that you could have 3 trades at $100 a piece, 6 trades at $50 a piece, 12 trades at $25 dollars a piece or any combination of the above; considering that you never spend more than $100 on a single trade and never have more than $300 in active trades in the market at any given time.
Final Thoughts
Capital management is a key factor to any profitable trader’s trading strategy. The rules above cap risk while still allowing for solid rewards. Following the 5/15 or 10/30 rule will ensure that even on your worst day, you never lose too much of your capital; making trading a safer investment for all!
