We looked at techniques to help ensure long-term survival and capturing profits such as being adequately capitalized 2-for-1 money management and taking windfall profits. And finally, we touched upon the psychological impact of losses.
It’s surprising that even many active traders and investors have no idea what money management is about. They generally entertain a fuzzy notion that it has to do with setting stops, and that discipline is involved to make sure you execute the stops when they are hit, but their understanding doesn’t go much further. Most people seem content to let their brokers track their trades for them, and the tools provided by the brokerage sites are adequate to the task.
But none of the online broker rating services tell you about brokers who provide the tools to help you manage these risks, and none of the traditional online or even most hyperactive day trading b brokerage firms seem to cover this important contributor to trading success. Why is this? Perhaps it can be explained by the extended bull run this market has enjoyed since 1982, and the speculative, maniacal extended leg of the bull market fueled by the dot.com land rush since 1997.
This type of market — where making money consists of taking a ride on the back of the bull trend and buying the dips — tends to turn the merely bold (and possibly reckless) into market geniuses. The perceived risk in stock market investing has been very low, so the need to manage that risk has not been a pressing concern. Why worry when it will always come back and you can make a killing if you buy more? More important to success than managing risk was the ability to charm your broker into getting you into the latest IPO allocation.
There are really two types of people operating in the financial markets: traders and investors. It is useful to understand the difference between the two — it may explain, in part, why so many people ignore risk management. Many people who call themselves traders are, in reality, active investors. The typical investor only purchases stocks and buys as many as possible with all the available cash in his or her account. The risk-free position, for the typical investor, is to be fully invested in stocks for the long term, because, as we all know, stocks always go up.
