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Cash Management

If you are trading on margin, cash management is a very important part of your trading. If you over-trade your account, you are doomed to lose money.

Even if you trade in your IRA account cash-secured puts and covered calls, and you can theoretically go full in, I still recommend applying the rules mentioned below.

When trading a margin account, the account buying power can fluctuate a lot. One day you will see your Net-Liq a hundred percent up, the next day it will look like you are going to bankrupt.

And you can for sure get into trouble if you over-trade your account and do not respect your cash management rules. Then devastating margin calls can come.
 

In a margin account, you have two options:
1) Ignoring margin and trade cash-secured (make sure you always have 100% of cash for a potential assignment). This will in my opinion limit your ability to use the full extent of your cash power. But it is safe.
2) Use margin and follow the below rules to stay safe.
 

 
I further structure this rule and do not use all available limits. There are two reasons for it.

One reason is based on the market conditions. I look at the level of the market. If the current price of the entire market is at an all-time high or making a new all-time high, I use even less than 40% of available money (buying power). I use only 15% in this situation.

Why? When the market is at all-time highs, the probability of it falling or crash is high. The very next day it can fall hard in a violent sell-off and it can drop 600 points in four days before you even blink an eye. We have been there, right? Just look at the August 2015 sell-off.

But as the market continues falling off of the all-time highs, the probability of it recovering is a lot bigger than the probability of further falling. Thus I employ more money.

Long story short, the more the current market price is off of all-time highs the more money I use up to the 40% limit. The closer the price of the market is to all-time highs the less money I use.

This will protect you from damage. Even if you use only 40% of your total available cash and the stocks fall hard, you still may get dangerously to the maximum of your available money for trading and wiped out by margin calls.

The second reason for structuring this limit is that you need money for repairs. And this is also a reason why I recommend using this rule even in ROTH IRA or simple IRA or any other cash-only account.

You will never be able to have all your trades 100% correct and winners. There will be trades that will go bust the very second you open them. And you need money to be able to roll those trades or repair them. If you are already maxed out, you will never be able to fix those trades and you will be forced to close them at a loss.

Here is a table I use to determine what percentage of my account I can deploy based on the market situation:

 

Market off all-time high Money invested
<5% 15%
5% – 10% 30%
11% – 20% 40%
21% – 30% 50%
31% – 40% 65%
41% – 50% 70%

 

I created a spreadsheet for myself which calculates the numbers mentioned above for me automatically. The spreadsheet is shown at the top of this page. It shows the all-time high of the market, current price, how many percent it is off of the highs, and based on that it selects how much money I can trade.

If the market is 4% off of the highs, then it is less than 5% and I can only trade 15% of my entire available buying power. And if I am over-invested then I do not open new trades until I get my account back to the limit level.

In the past I was breaking these rules blatantly and I also paid for it dearly. I try not to do it again.

The table at the very top can help you too. You can use the column indicating “off highs” and then on the line “Max cash to be traded” the second column indicates how many percent of your own money you can trade.

Good luck!





7 responses to “Cash Management”

  1. Gabriel says:

    Hi Martin! I would like to have the excel you mencioned above. I really apreciate it!

    Thank you.

  2. Milos Kami?ski says:

    Thank you for sharing your experience. I found very valuable advice for myself “Always use only 35% – 40% of your buying power (or account cash value) for trading.”

  3. Denver Nario says:

    Thank you for the pointers! Your blog is a great resource for me as I am also building my own in the same niche. I think I’m going to learn a lot from you.

  4. […] work for you! Try to invest upwards towards 15% of your monthly income – but make sure you are managing cash wisely so you don’t end up in a pinch. If available at your income level, try to max out ROTH IRA’s […]

  5. MU says:

    Hi Thanks so much for your strategy sharing. It’s really helpful!

    A quick newbie question: how do you calculate the delta for your Iron Condors or spreads?

    • Martin says:

      MU,

      I use delta for short strikes and you do not have to calculate it. Every broker should show you delta for each strike price in the trading platform. So if I want to trade delta 0.10 I go to the chain, find that delta and that tells me the corresponding strike. Then I sell that strike. Then if I trade 10 dollar wide spread I add 10 dollars to that short strike and buy the resulting strike. See the attached picture (you can click on it to enlarge it).

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