What Is Money Management?
💡 Definition
Money management is the set of rules that control risk per trade, portfolio heat, exposure, and capital growth. It turns a trading idea into a survivable, scalable process by constraining losses and standardizing gains.
Strategy picks entries; money management decides how much to risk, when to scale, and when to stop. It is the difference between a good system and a durable business.
Visual Overview
Capital → Risk Budget → Position Size → Heat/Stops → Compounding
Set a fixed risk per trade, compute size from your stop, cap portfolio heat, and respect drawdown limits to keep compounding intact.
Core Components
🎯 Risk per Trade (r%)
Typical ranges: intraday 0.25–0.5%, swing 0.5–1.0%, position 1.0–1.5%. Smaller in drawdowns.
🔥 Portfolio Heat
Sum of open risks (in % of equity). Cap at 3–6% depending on correlation and volatility.
🧭 Exposure & Correlation
Limit per-name, per-sector, and factor exposure. Reduce size for highly correlated positions.
🛡️ Drawdown Controls
Daily/weekly loss limits (e.g., 2R/day, 5R/week). At max DD (e.g., 10–15%) halve r% or pause.
📈 Compounding Rules
Update size when equity changes by bands (e.g., every ±5%) to avoid constant rescaling noise.
🚫 Prohibited Tactics
No martingale/averaging-down. Never widen stops. No oversized single-name bets.
Key Formulas & Checkpoints
Sizing & Heat
Risk = Equity × r%Units = Risk ÷ StopDistanceHeat = Σ r% (open) ≤ HeatCapExpectancy & Ruin
E = p×AvgWinR − (1−p)×AvgLossR= 1 / (1 + RRR)Use Monte Carlo on your R-distribution to pick safe r% and HeatCap.
Kelly (Use Fractional)
f* ≈ p − (1−p)/b where b=win/loss in RPopular Money-Management Methods
📏 Fixed Fractional
Risk a constant % of equity on each trade (e.g., 1%). Simple, adaptive, widely used.
🎚️ Volatility Targeting
Scale exposure so portfolio’s realized/smoothed vol ≈ target (e.g., 10% ann.).
🪜 Scaling & Pyramiding
Add on confirmation (e.g., at +0.5R/+1R) while keeping total heat ≤ cap.
🧊 Equity Bands
Adjust r% only when equity crosses ±X% bands (e.g., −8% DD → r% × 0.5).
🧮 Fixed Ratio / Delta
Increase size after cumulative profits reach thresholds. Good for futures/options systems.
🧯 Hard Loss Limits
Stop trading for the day after −2R or week after −5R; prevents tilt and overtrading.
Why Money Management Works
- Survival First: Small, controlled losses keep you in the game long enough for edge to play out.
- Variance Control: Heat caps and DD guards stabilize equity and psychology.
- Adaptation: Volatility-aware sizing fits changing markets; equity bands avoid over-reacting.
- Compounding: Consistent R accounting lets positive expectancy scale cleanly.
Practical Playbook
Daily/Weekly Checklist
1) Set r% and HeatCap (e.g., r=0.75%, Heat=4%).
2) Precompute position sizes from stop distances (or ATR multiples).
3) Respect daily/weekly loss limits (−2R / −5R). Pause or cut r% if hit.
4) Track results in R-multiples. Review expectancy monthly.
5) Reduce r% when DD > 8–10%; restore gradually as equity recovers.
6) Watch correlation; avoid stacking similar bets that blow through HeatCap.
Common Mistakes
⚠️ Avoid These Errors
- Trading without predefined r%, HeatCap, or loss limits.
- Martingale/averaging-down into losers; widening stops.
- Using the same size for assets with very different volatility.
- Ignoring slippage/fees in expectancy calculations.
- Constantly resizing every bar — overfitting and noise sensitivity.
The Bottom Line
Money management is your risk operating system. Fix a small per-trade risk, size from stops, cap portfolio heat, respect drawdown and loss limits, and scale exposure methodically. With those guardrails, even modest edges can compound reliably.