The Traders Journal

Tensile Trading: Stage #1 is Money Management

6a0105370026df970c01901e687387970b-800wiMoney management is the first step to becoming a consistently profitable investor.  It’s all about working wisely and moving the odds in your favor.  Succinctly put, it’s about:

  1. knowing what you’ve got
  2. knowing how to protect it
  3. knowing how to grow it
  4. writing it out in a personalized investment plan.

I continue to observe many investors who insist on jumping impulsively onto item #3 with both feet right out of the blocks, while ignoring items #1, #2 and #4.  Yes, item #3 – growing your assets – is indeed the most sexy and flashy of the four elements, but if you pursue this item first, you’ll kill your odds for success.

We have to first build a solid foundation.  At the most fundamental level, that means you must learn to speak the language of the market.  Every profession – medicine, engineering, accounting, law – all have their own unique vocabulary.  Investing is no different.  If you don’t know the difference between a market order versus a limit order, it will bite you.  Education is a prerequisite, and learning on the fly can be expensive. 


 

I also suggest you learn how the market is structured.  For example, Dow Jones, Standard & Poors, and the Russell Company have all created unique indexes or groupings of equities, and they get paid a licensing fee by users of their indexes.  The point to remember is that all three companies are slicing and dicing the very same market, so the S&P 500 is actually a subset of the Russell 3000.   Don’t let all this slicing and dicing confuse you, no matter how hard they try!

Having said that, I’d like to address item #1 above:  knowing what you’ve got.  Before you can pass “GO” and collect $200, or even before you begin to play the game, you must dig out all your personal financial data  and  load it into Quicken or some other software organizer, so that you will have a precise understanding of what assets you own and where they are invested.  I update my net worth statement every January, and there is not a new year that arrives without some element of surprise within this document.  This kind of organization is not optional!

Let’s address item #2 above:  knowing how to protect it.  We could energetically debate whether a great defense beats a great offense in football or other sports, but in the investment arena, building a premier defense for your assets is paramount.  Not to shock you, but there are indeed folks (and governments) out there who will try to take your money any way they can – illegally as well as legitimately.

Remember that you must first and foremost protect your capital, as there will always be another investment opportunity down the road if you do so.  If you don’t, there won’t be one.  Start your To-Do list with basic items such as insurance, an estate plan, identity theft protection, effective tax strategies and accurate recordkeeping.  Once you’ve done so, you can expand the list from there. 

Money management is consistently referred to as the “secret sauce of the Market Wizard set”.  Ignore this caveat at your own peril!  A bare essentials definition of your money management would include these elements:

  1. making it a very personal and appropriate financial framework document
  2. putting it in writing
  3. describing all your goals, objectives and priorities
  4. outlining your investment methodology and strategies
  5. describing your investing tools and rules
  6. acknowledging  your risk tolerance  and describing the risk management techniques you employ to protect your assets
  7. updating it on a regular basis.

Trying to invest without a money management document of your own is like trying to nail Jello to the wall.  There are two essential halves.  You must deploy a hands-on approach to writing your investment plan, and then you must believe in it.   In order to believe in it without wavering and to trade your own hard-earned money based upon it, you must build that plan yourself.  It’s an important circle of trust.

Also, part of this circle is to embrace and understand the “law of probabilities”.  Nothing is ever 100%, but you can take explicit well-defined steps which will move you closer and closer to that ideal.  As an investor, probabilities and your personal beliefs matter big time. 

To recap:  Stage One of Tensile Trading is money management, and the foundation at the core of good money management is preparation.  George Washington understood this.  When young George was given three hours to cut down a cherry tree, he spent the first two hours sharpening his saw.  A carefully written investment plan is like a very sharp saw.  As an individual investor, the sharper the saw, the more consistently profitable you’ll be as a manager of your money.

Trade well; trade with discipline!
-- Gatis Roze

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