In my post “How to create the best investment strategy” I wrote about how to start saving and investing money with small account, with small amount of money saved every month. I practice it myself in my accounts. I also advocate having two to three investing accounts with two to three different strategies and approaches to boost your investment results. I recommend having a very conservative account where you invest into selected mutual funds or index funds and you should apply a buy and hold strategy. Your another account should be more aggressive and well managed to improve your results. I do it this way myself. I have a 401k and ROTH IRA accounts, where my 401k is considered as the conservative one, ROTH IRA will be more aggressive account, but still I will be investing mostly into mutual funds and ETFs and the last account is the most aggressive investing account for trading stocks and options. In this post I will tell you about a money management you can theoretically apply on any of your investing accounts, but definitely it should be applied when trading stocks.

The conservative accounts may provide you with returns anywhere between 5% to 20% annually, unless you get hit by recession or any similar disaster. If you are, however, adventurous and proactive and you do not want to take a passive approach when investing, you are probably looking for a strategy which can boost your results and double or triple your returns. So do I. Before I will tell you about a money management let me clear one thing: no matter what, never invest all your money in only one account or using one strategy. If you are looking for an aggressive strategy, you should use only part of your money in such a strategy, not everything. To remind you what I am talking about look at those people who lost all their money with Madoff.

I myself allocate my surplus savings this way:

Accumulation phase – emergency account & debt management

• 3% of my salary goes to my 401k and 3% I receive from my employer.
• 17% of my salary goes to my debt, which shall be paid of in about two months from now (ca. the beginning of October 2009).
• 8% of my salary goes to my emergency account (should be fully funded by the end of 2009).

Accumulation phase – investing

After my debt is off i change my savings the following way:

• 3% of my salary goes to my 401k and 3% I receive from my employer.
• 17% of my salary will go to my ROTH IRA and be invested as I described in “How to create the best investment strategy“
• 8% of my salary will go to my investing account and will be used to invest in stocks and options.

Since I am allowed to trade stocks with margin I can afford buying stocks with smaller money and keep my expense ratio relatively small. This is why I am not accumulating in this account.

Money management, what is it and how can money management help you?

If you are a novice investor as me (and as Jesse Livermore called us “suckers”), you were probably searching for the strategy which would provide you with great results and protect you against losses. I have been searching the internet and reading books about this topic for more than two years. I have found plenty of information on this topic, but a very few were useful and understandable to apply and manage.

I have been through almost all trading strategies (the question is whether I can call my early trading as a strategy at all). At first I was making money and I became proud of myself what a trading genius I am. However later on as I traded more often and started shorting stocks the results were dropping to become worse than mediocre and after about a year of active trading I lost 60% of my account. Fortunately I realized that this is not correct and I started to do something about it. I bought my first books about investing and trading and started searching for the best strategy ever.

I met (in my virtual world of books) traders such as Jesse Livermore, Nicolas Darvas, William O’Neil and others. I liked their stories and trading success. I also liked their strategy as opposed to buy and hold 30 year-waiting-period system. I liked the idea that with some knowledge and training I can improve my return results in shorter term than saving for the whole life, and when finally being allowed to start withdrawing from a pension account, to die. When I read the Way of the Turtle by Curtis Faith (one of the turtles) about an experiment performed by R. Dennis and literally stating that trading skills can be taught and learned and no credentials and talent is required I realized I can do it as well. What I didn’t know that time was that it would take me another two years to even grasp what to do and where to start.

During my searching and learning I found many references to a money management plans. All of the sources were providing information that a proper money management can save you money and protect you against losses. However very little of those sources told me how. The only information I could get was to place 10% stop loss order below your purchase and “you will be fine”. Heck. I started collecting 10% losses. Every single trade was a ten percent loss. When I added them all together, my account suffered another huge loss. I doubted whether the market timing trading really works as many buy-and-hold strategists trumpet their warnings about this strategy to the world. There must be a way! There were many traders who lived on it! Livermore did trading for a living only and he was able to bankrupt and get back again and made his millions back just by trading. He was trading his whole life since his 13 birthday. It wasn’t a pure one time luck as some advisers may tell you about market timing. After almost three years I was able to break through and finally started working on a management which works.

The secret of the proper money management is in position sizing and limiting. With the plan I will describe later you will be able to open as many positions as you wish and as big or small as you wish and as the rules allow you! Such a plan will help you to organize your trades and if they turn against you the plan saves you money by limiting the loss to a very minimum.

Will be continued…