Money Management is the management of the money used in all of our assets, and its primary goal is to control risk.
Managing your money wisely is the real dividing line between success and failure, and that is why many trader or followers investor have difficulties at first, because they underestimate the importance of money management in their investment strategy.
Even the most profitable and successful strategy in history could cause you serious problems if you don’t have a clear idea of how to manage risk, and therefore your capital.
Let me make an extreme example to let you understand properly. Let’s suppose you’ve found a strategy that wins 99 times out of 100, a real prodigy, almost a miracle. Enthusiastic, you take your 10,000 usd account and you bet everything of this strategy. Unfortunately, the first transaction made was that single losing operation out of 100. After that one, the system started with the other 99 winning trades in a row. Too bad for you though, because by betting everything, on that first trade you have burned your balance and you have set yourself out of the game just before you were about to get rich.
Now you have clear the concept of what it means Money Management for risk management.
Any investment, any strategy, any Signal Provider carries a certain level of risk. It’s inevitable and it’s part of the game. The ability of the investor is to assign the right amount of capital to each piece of the strategy, so that the whole structure can continue to operate efficiently and with as little risk as possible.
In Social Trading, since it’s a real form of investment, we must decide which and how many Signal Provider to include in the portfolio, how much capital to assign each, which Lot Size to assign to each Signal Provider according to the assigned capital’s share, and finally, the control levels for making future management decisions.
All of these actions concur to shape our Money Management.
How much capital to assign to a Signal Provider
Any Signal Provider brings with him his strategy and his performance, with its relative parameters, peculiarities, performance levels, but especially risks. From all these parameters derive the Money Management reasoning, designed to indicate what is the ideal piece of capital to be allocated to the trader, so that he will produce his best performance, putting the least possible at risk the portfolio stability.
How much to assign also depends on your initial investment objectives. It’s clear that, if you have a conservative goal, you will give more space to very quiet Signal Providers, and you will diversify with a smaller slice assigned to some more aggressive Signal Providers. Conversely, in case you want to instead aim at a great return on the investment.
Speaking in terms of percentages, a good money management strategy could be to allocate 50-60% of the portfolio in Signal Providers suited to your goal (aggressive or conservative), 20-30% in opposites Signal Providers (or with different characteristics) in order to diversify, and leave the remaining part of your balance as protection capital.
We believe a lot in the protection capital. Social Trading is an investment that allows incredible returns on your capital, but it also brings risks that should not be underestimated, especially when you consider the fact that the management is entirely in your hands, and you may not have the slightest experience in this field, but only theoretical concepts.
To keep a slice of capital out of the game means to protect yourself further, in the event of serious errors or unexpected events. Should you encounter some obstacles along the way, that slice of capital will always be ready to give you back a bit of oxygen. You will then see in more detail what we mean.
Deciding these percentages is more an art than a mathematical process, and the experience is definitely what will help you the most in finding the best investment portfolio calibration and the right money management strategy.
However, there are also mathematical formulas that can help you figuring out how much percentage of capital a Signal Provider can handle according to his performance.
Obviously, the percentage values will impact on the number of Signal Providers you can use. If you have decided to dedicate the 60% to aggressive Signal Providers, then you cannot use 5 traders that, according to certain mathematical formulas, should occupy a slice on your account equal to the 20% each.
How many Signal Provide to use
So, now you’ve decided the percentage of capital to use for your strategy.
The next step for a good money management is deciding how many Signal Provider to use. In addition to what has been said in the preceding paragraph, we must also think about the account’s balance capacity, because if you have a small account and you follow too many Signal Provider, you may not have enough margin coverage to replicate all the transactions, as explained in Forex . This is Money Management too.
In general, it’s better not to overdo with the number of Signal Providers, for the sake of simplicity in the management, and for what Warren Buffet said: Wide diversification is only required when investors do not understand what they are doing.“
you don’t need tens of Signal Provider to give an impression at the portfolio according to your goal. Study many Signal Providers, but in the end choose your favorite, focus on those, and learn to know them as much as possible.
Which lot size to assign to a Signal Provider
This is one of the most important topics about Money Management in Social Trading.
“How many lots, or mini lots or micro lots should be assigned to each Signal Provider?”
The answer is not easy, but math and logic can offer a great help.
- The lot size must reflect primarily the percentage of capital we have decided to assign to that trader.
- It must reflect the level of risk of the trader himself.
Again, to combine these elements perfectly is a practice you can acquire with time and experience, but to create for you an excellent starting point for a good money management you can start using some calculations.
The most important value in this case is the Max Drawdown, and it’s easy to guess why.
If past performances are not a guarantee of future performances, it’s still true that they are a possible preview of what you can expect. In any case, they are what you should rely on to make your best decisions. With this in mind, the Max Drawdown value is a very good indicator of the worst you might expect from a Signal Provider.
The worst Signal Provider’s experience is what , for translation, you might experience too, if the trader will replicate such a moment.
This means that the Signal Provider’s Maximum Drawdown is the fundamental value to understand how much risk we can tolerate, how much money we are willing to risks, and therefore what lot size that Signal Provider can handle.
Money management monitoring levels
Now that you’ve clear all the parameters for setting the Signal Provider’s operation within your portfolio, let’s see what is left to do about money management.
It remains to establish what the levels of control for your capital’s evolution should be.
Let’s say that a Signal Provider encounters a drawdown period that has never occurred so far, thus creating a new Max Drawdown level. At that point you should go to review the trader’s statistics, and maybe also update all his settings.
You also need to be clear about the level of expectation on the maximum general and cumulative losses of the account. Imagine if all the Signal Provider should produce at the same time their worst historical performance, and calculates how much your account may be affected by that. If you were to reach that level, it means that it’s time to reconsider the whole portfolio structure, and particularly the choices about the Signal Providers.
These can be two negative scenarios. Now it comes the good one.
There will come a time when your earnings will allow your portfolio to make a step further. Your capital will be raised enough to support an increase of the Lot Size assigned to that Signal Provider, therefore to begin to deal with larger capital for the progressive growth of your account.
Also being clear about this level is part of a good money management strategy.