Money Management Is Not Enough
money management edge analysis
There is a trading proverb that says, “Even a poor trading system could make money with good money management.” Have you heard that saying before? Well, if you have, forget it, because it is really one of the stupidest things that has ever been said about trading. If you believe that good money management can salvage a poor system or methodology, I invite you to go to a casino, walk over to a roulette wheel, use your best money management system to bet, and see how well that works out for you. In fact, if you asked a hundred mathematicians the question, “I have $1,000 that I want to bet in roulette—what is the optimal betting strategy I should use?,” all 100 should give you the same answer: Take the entire $1,000 and place it on red or black (or on odd or even) for one spin, and then, win or lose, walk away. That betting strategy will give you the highest probability of being a winner in roulette.
Of course, your odds of winning are still less than 50 percent—47.37 percent, to be exact, for a wheel with a double zero—but your negative edge will be smallest for one spin. The more times you play, the greater the probability that you will lose. And if you play long enough, it is a mathematical certainty you will lose. So the point is that if you don’t have an edge (implying you have a negative edge), then the optimal money management strategy is to bet it all at once—the epitome of bad money management. Money management cannot save you if you don’t have an edge. It is helpful in mitigating losses and preserving capital only if you do have an edge.
So, it’s not enough to have money management; you also need to have an edge. Having an edge means that you have a method.
No trader I ever interviewed for any of the Market Wizards books when asked how he did what he did gave a response like, “I look at the screen, and if bonds look good, I’ll buy some.” None of them approached trading with a cavalier, shoot-from-the-hip attitude. They all had a specific methodology. Some of them could describe their methodology in very specific, almost step-by-step terms. Others described their approach in more general terms. But it was clear they all had a specific methodology.
Jack Schwager Market Wizards
So what exactly is your methodology? If you can’t answer that question, you are not ready to be risking money in the markets. If you can answer that question, the next question is, “Does your trading method provide an edge?” If you are unsure about the answer, again, you are not ready to be risking money in the markets. Successful traders are confident that their methodology provides an edge.