This post was written in 2009, since then, I have delved a lot deeper into money and risk management.
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Every self proclaimed guru out there tells you how a money management plan (mm plan) is essential. They tell you that you will fail without one and some even try to show you how to write one. However, very few (if any at all) give you an actual example of a real mm plan.
Well since I am a real trader, I write mm plans routinely. So I am going to explain in detail how to write a proper mm plan. And after I explain it I will link you to a PDF with a sample mm plan. Even though it may seem slightly complex to start with this type of plan is very simple. It is also less than one page long and it has everything it needs to structure your trading.
As far as I know this is a unique type of money management plan only I use. This kind of money management plan is based on NickB methods targets which are fixed. However, it is versatile and it can easily be changed to suit methods with non-fixed targets and stops.
We are going to use a $10,000 USD account as an example. The example pair will be GBP/USD and we will be trading mini lots at 100:1 leverage. This means every mini lot is worth $100 USD and every pips is worth roughly $1 per mini lot. So if you trade 2 mini lots each pip is worth $2 and if you trade 17 mini lots each pip is worth $17.
Depending on the pip value the actual amount risked varies. Some pairs will give you $1.07 per pips some $0.97 normally the difference is small enough that you do not need to worry
Ok let’s look at how to write a money management plan.
Step 1: Write down your account Type & Size
Simply make a note of your account type and size. So for this example plan you would write something like this:
I am trading a mini account with exactly $8,000 in it. So I am trading $100 per trade and making $1 per pip.
Step 2: Write down your maximum target and stop in pips for each trade and the pair(s) you trade
Write down your maximum target and stop for the pair(s) you’re trading.
This is simply your maximum target and stop for a normal trade in your method/system. For some crazy reasons many trader set their maximum target and stop based on their mm plan. This is silly because you target and stop need to be based on the movement of a pair.
So for example in my method (NickB method) I know that when breaking a scalp line GBP/JPY is likely to move about 80 pips. If it goes bad I do not let it go more than 70 pips against me before closing out. Therefore my target is 80 pips and my stop is 70 pips. This is based on analyzing every line break for the past year or so.
Your money management plan should be built around the target and stop for your method. So my plan is built around the 80 pip target and 70 pip stop I have on GBP/JPY.
However, for this we are targeting 50 pips with a stop loss of 35 pips. So you would write something like this:
Pair = GBP/USD
Target = 50 pips
Stop = 35 pips
Step 3: Write down your goals
All you do here is write down your goals for the account. For this example account our goal is to take it from $10k to $20k so you would write something like this:
My goals is to take my account from $10k to $20k in under a year. Ideally I would want to reach this goal in 6 months but realistically it would probably take a bare minimum of 9 months. I do not want to take any money at all out of this account.
Step 4: Write down your rules
If you have any rules like the max draw down (you should have these kinds of rules) you add them here. For this example I am simply putting in the ‘3 trade rule’ which I have been using in my mm plans for years:
If I lose more than 3 trades in a row I will take a break for a week and come back to trading with a fresh and clear mind. So my maximum draw down is 105 pips (35 x 3).
Step 5: Calculate and write down the maximum % risk on each trade
There are several schools of thought on what you max risk should be. I personally believe it should change with your account size. Currently I risk 0.5% but my account is rather large. If you have a tiny account you may be better off risking as high as 5%.
Generally speaking though you should not risk more than 3% per trade and under no circumstances should you risk more than 5%. 5% itself can be seen as too much risk so anything above that is crazy. In this example we will stick to 3% risk as with a $10k account 3% is plenty.
So to figure out your risk per trade just calculate 3% of your total account size ($10k).
3% of $10k = $300
To calculate the percentage of any number you simply divide the number by 100 and then you multiply it by the percentage you need. So for this example:
10,000 / 100 = 100
100 x 3 = 300
So now you know that on a $10k account you can NEVER risk more than $300.
You also know that with your method on a trade you risk 35 pips. Now you need to use those two numbers to figure out the max lots traded on each trade.
Step 6: Calculate your maximum amount of lots traded on each trade
Remember than in this example when trading a single mini lot you make $1 per pip. If you are trading 10 mini lots you are making $10 per pip. If you are trading 17 mini lots you are making $17 per pip.
Now you need to calculate how much each pip should be worth in $ to stay within the 3% max risk with a max loss of 35 pips. Wow that’s a mouthful, basically what you are figuring out is how many lots you can trade.
So you take $300 and divide it by 35 pips.
$300 / 35 = $8.57
This means that when you take a trade each pip should be worth $8.57. This is because when you multiply $8.57 by the amount of pips you risk (35 pips) you get $300 (your max risk).
Assuming the smallest amount you can trade is a mini lot you have to round this down to 8 mini lots or $8 per pip. You should always round this number down. Rounding the number up will push you over your 3% max risk. For example:
$8 x 35 = $280
Falls nicely within your 3% risk.
If you round it up to 9 lots you will be risking a little too much:
$9 x 35 = $315
What You’ve Done So Far
What you have done so far is calculated how many lots you can take per trade. Now it is time to make a plan on how and when you will start trading more lots.
To grow your account the more money that you make the more lots you should start trading. However, you should obviously always stick to your 3% max risk. The best way to decide when to trade more lots is to follow the 10%-20% guideline. Every time you grow your account by 10%-20% you should recalculate the amount of lots traded. So to make it easy on a $10k account every time you grow your account by $1k you should reassess amount of lots traded.
So you use the mathematics above to figure out how many lots you will trade as your account grows.
When you’re at $10k
3% of $10k = $300
$300 / 35 = $8.57 (round down to 8 )
Trade = 8 lots (since each pip is worth $1 per mini lot traded)
When you’re at $11k
3% of $11k = $330
$330 / 35 = $9.42 (round down to 9)
Trade = 9 lots
When you’re at $12k
3% of $12k = $360
$360 / 35 = $10.28 (round down to 10)
Trade = 10 lots
When you’re at $13k
3% of $12k = $390
$390 / 35 = $11.14 (round down to 11)
Trade = 11 lots
When you’re at $14k
3% of $12k = $420
$330 / 35 = $12
Trade = 12 lots
Of course it is much easier to plot this all in a nice table.
Cool now you have a nice little table that tells you how many lots to trade every time your account jumps up $1,000. This gives your trading some structure.
Now if you want to you can take this one step further and give yourself some nice pip goals. This will allow you to figure out how many pips you need to make before you can trade more lots.
Starting at $10k trading 8 lots your goal should be to start trading 9 lots. You know you can do that when your account size reaches $11k but how many pips way is that?
Well you need to make $1,000 to reach your target and at 8 mini lots you’re making $8 per pip. So simply divide $1,000 by $8.
1,000 / $8 = $125 (125 pips)
Now you know that when you reach $11k target in 125 pips you can start trading 9 lots. What about reaching $12k with 9 lots
$1,000 / $9 = $111.11 (round up to 112 pips)
It is very easy to figure out how many pips it will take to reach the next target based on lots traded. Now you can add this column to your table.
Great now you know how many pips you need before you can start trading more lots. Imagine you need to make 125 pips to reach your next target. If you lose 35 pips on a bad trade you now have 160 pips to reach that target. If you then have 3 good trades in a row (+150 pips) you only have to make 10 more pips to reach your next target.
This always worked for me. I am a competitive person so I loved having a pip goal to reach for.