This is the first of three planned posts on the subject of trading tactics. I’ll be covering money management this week, followed by risk management and trade management over the upcoming two weeks.
The boundaries between these three subjects are somewhat fuzzy and open to individual interpretation. For our purposes, I’m defining money management as the movement and allocation of financial resources across your entire set of investment and trading accounts. Think of it as how many eggs you have, how many baskets you have, and how you distribute those eggs among those baskets. If all your eggs are gravitating towards one basket, that’s a signal to redistribute!
You’ll have to develop your own money management strategy and rules based on your own situation and goals. Here, I’ll just be describing my own overall strategy as an example. So I’m not recommending that you allocate your funds the way I do. I just want to illustrate why you should think about an overall strategy. In the next two posts I’ll get to the nuts and bolts of specific trading tactics within a forex account.
Any strategy has to start with a goal, so here’s mine: I want to to live well on a stable income from passive investments. This will allow me to spend time doing things that are more important to me than just chasing money and trying to survive. In the words of the villian in “Die Hard,” I plan to one day be “sitting on a beach making 20%.”
Again, your goals may be different, so your strategy will differ too. While I make a distinction between my trading and investing accounts, you may only be interested in one or the other. While forex trading is only one of several different trading activities for me, it may be the only thing you do. Keep that in mind as I describe my own plan below.
Take a look at the diagram below. My overall money management strategy is based on a triad consisting of employment / business income, trading, and income investing.
In this post on the realities of trading, I stressed the importance of not quitting your day job to pursue a life of trading. Having the relative security of an income that isn’t dependent on your trading prowess helps to avoid those emotional mistakes that plague many traders. When your next meal depends on your next trade, that’s a recipe for disaster.
Notice that in my strategy diagram, everything flows from my employment and/or business income. Obviously this is how I pay my living expenses, but it’s also how I add more funds to my trading and investment accounts. I allocate any surplus funds to these accounts based on (among other things) how profitable they’ve been. Winning strategies get more funding while losers get cut off.
In my case, I have some scheduling flexibility in my job, so as I generate more income from my passive investment accounts, I’m able to reduce my employment hours accordingly. My overall goal is to eventually be generating all of my income from passive investments instead of from employment.
Note also that I’m not planning to draw from my trading accounts to live. For me, trading is an intermediary step between employment and passive investment income. While some might find the idea of trading for a living exciting, it’s a bit too exciting for me. I don’t want to constantly be chasing the next trade in order to pay the rent. So instead, I use the profits generated from my trading activities to fund my passive investments. It’s those investments that will eventually pay the rent.
Finally, did you find where my forex trading fits into the overall plan? Yep, for me, it’s just one of several different trading activites. This illustrates the advantage of having an overall money management strategy. By not keeping all of my eggs in one basket, I can jostle each basket a little harder, even at the risk of breaking a few eggs. In other words, I can take somewhat greater risks in my forex account in order to generate higher returns. That’s because it’s not my only trading vehicle, and a large loss in the account won’t destabilize my entire financial plan. Neither will a sudden regulatory change that restricts retail forex trading, etc.
For the curious, I’ll describe my various trading and investment vehicles in more detail below.
My ultimate financial goal is to build a portfolio of stable, conservative income assets.
In my retirement brokerage accounts, this would consist of taxable instruments like high grade corporate bonds and bond funds. Income equity funds would go into these accounts as well. The reason we put taxable instruments in retirement accounts is because while their nominal yields are higher than tax-preferred instruments, that yield is shielded by the tax advantages of the account.
In non-retirement accounts would go the tax-preferred instruments like government bonds, municipal securities, and Master Limited Partnerships (MLP’s). Oil and gas MLP’s are one of my favorite investments, and I often wrote about them for the Motley Fool. Again, the reason we put tax-preferred instruments in non-retirement accounts is that they have lower nominal yields, so their tax advantages would be wasted in a retirement account.
I allocate funds to several different trading activities based on factors like how profitable the activity is, how time consuming it is, how risky it is, etc. Here’s a rundown of the trading vehicles that I’m currently using, have used in the past, or plan to use at some point.
Equity indices: Over the past few hundred years, the stock markets of the U.S. and other nations have risen steadily, notwithstanding the various famous crashes and panics. So it makes sense to me to have constant positions in securities that track the major indices like the DJIA, Nasdaq, S&P, etc. These can be Exchange Traded Funds (ETF’s) like the diamonds (DIA), the cubes (QQQQ), and the spyders (SPY). Index funds are another alternative, especially if they have low or no trading commissions. This is because I don’t just buy and hold such securities. Instead, I use variants of Robert Lichello’s Automatic Investment Management strategy to trade around core positions in these instruments.
Equities: I trade individual stocks using William O’neill’s CANSLIM method. I’ve found this to be the most consistently successful approach to picking stocks, and recommend the Investor’s Business Daily website to anyone who’s interested in this market.
Options: I’ve traded both equity and index options in the past, but haven’t done it for several years. I consider this more of a complimentary technique than a standalone trading vehicle.
Forex: Since most of the e-books, discussions, and trading tools on the site are dedicated to currency trading, I don’t think I need to elaborate on this here.
Binary options: I haven’t tried trading these yet, but I like the concept a lot. At some point I’ll open an account with Nadex and try it out.
Crypto-currencies: This is BitCoin and other variations on the idea of a blockchain based currency. I’ve had an account at Coinbase for quite some time, which I can use to trade BitCoin, Etherium, and LiteCoin. Because of the volatility of these instruments, they’re perfect for Lichello’s AIM technique.
VirWOX currencies: These are currencies used in on-line virtual worlds such as Second Life. The Virtual World On-line Exchange (VirWOX) facilitates trading in these currencies, all of which can be exchanged for real-world currencies like the U.S. dollar and the euro. I opened an account with a small amount of cash as a fun experiment, and have nearly tripled my money in a little over a year. That’s because this is a very obscure and inefficient market niche. I’m frequently able to take advantage of very wide spreads in certain markets here, just as a market maker would. In fact, I’m often “the whale” in some of these markets. However, there’s limited liquidity in these currencies, so there’s probably a low upper limit to how much money I can make in a given period of time. Also, I haven’t tried making a withdrawal yet, so all may be for naught if VirWox turns out to be sketchy. I’ll probably do a more detailed post on all this at some point.
As I mentioned above, forex trading is only a part of a much wider overall money management strategy. Because of that, I can seek higher risk/reward opportunities in my forex account without jeopardizing my entire financial strategy. In next week’s post, I’ll concentrate exclusively on my forex trading; specifically on the subjects of risk control and position sizing.
Until then…keep pipping up!
NOTE: As always, comments are closed due to WordPress spambots. However, to comment on this or any other post, just go to my Forex Factory journal.