The Second Cardinal Mistake:

I am constantly amazed at how few commodity traders and commodity brokers have no concept of money management. Money management is controlling your risk through the use of stops, while balancing your potential for loss against your potential for profit.

Let me give you just one example of poor money management. Many commodity traders refer to a trade that might lose them $500 if they are wrong and make them $1500 if they are right as a three-to-one risk/reward ratio - a "decent" trade. Yet, that is wrong because the most important aspect of a trade is not how much you are going to lose if you are wrong, or how much you are going to make if you are right, but what are the odds of making money, of being right. What are your odds of losing money, of being wrong?

Good money management means you know your profit objective and the odds of being right or wrong, and control your risk with stops. You are better off with a trade where you might lose $1000 if you are wrong, or make $1000 if you are right, that would work eight times out of ten, than to take a trade where you would make $1500 if you are right and lose only $500 if you are wrong, but works only one time out of three.

Obviously, this mistake can be overcome only by developing and testing money management concepts. An entire book could be written on money management, but some of the basic money management concepts that I have followed and found to be very successful over the past years are contained in an article that appeared in the July 1981 issue of Commodities magazine, which is available on our web site.

Next: The Third Cardinal Mistake: Failure to Use Protective Stop/Loss Orders

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