#MoneyManagement #RisikoManagement
...at the request of @DonkeyInvestor a few words about my Money Management. Maybe it helps you to limit the one or the other loss in 2023! From tomorrow it's going again - the bull market be with you!
1. introduction to money management / risk management
- What are risks?
- Why Money Management?
- The 3 levers for risk management
2. money management in theory
3. money management in practice
1. introduction to money management and risk management
I'll start with a quote (supposedly from William O'Neil - founder of Investment Business Daily): "The whole secret of stock market success is to lose as little as possible when you are wrong."
Warren Buffett also once said:
Rule number 1: Don't lose money.
Rule number 2: Never forget rule number 1.
...but now I'll leave it with the old hackneyed quotes, even if these two quotes actually describe the essence of risk and money management!
What are risks?
In principle, risks can be divided into 2 areas:
1. risks we cannot influence, like the general market environment, political events like the Ukraine war, or the interest rate policy of national banks like FED or ECB.
2. risks we can influence like "no" diversification, "no" knowledge or simply "no" risk management.
Money management also belongs to the area we can influence. For me it is the most important risk management besides diversification.
Why should we do money management?
It is difficult to recover losses!
The example of Tesla with a performance of -70% shows how difficult it is to recover this loss. Tesla would need an incredible performance of +233% to get back to the old price level. How realistic is such a +233% recovery? Better not to let it get that far. Buy&Hold is good, but not until the bitter bottom...
For the further course important to mention are the differences between short/medium-term oriented traders and long-term oriented investors. For traders, the money management and risk management in the form of stop prices, derived from opportunity risks in the foreground. For long-term investors diversification is the means of choice, the money management is more or less already done with the determination of the savings plans or the investment amount.
But I also recommend the Buy&Hold investors among you to think about Money Management. In reality, both are not so easy to distinguish from each other, the transitions are blurred. What the short term trader has to keep an eye on, the long term investor should do from time to time. Check your position sizes and think about exit prices, i.e. tighten any stops.
The 3 levers for your risk management are as follows:
1. diversification
2. correct use of capital (=money management)
3. loss limitation by means of stop prices*.
*I know that many here are not fans of stop prices, but it also makes sense for buy&hold investors. An example from my practice are "stocks for eternity" like Apple and Amazon. By consistently tightening stops I was able to lock in profits, along with a few other stocks these stocks were stopped out / sold near the high in mid-August. I was spared the massive drops in September and October. Since I still believe in the companies, I have now started to collect these shares again at much lower prices.
2. money management
What is Money Management?
Money Management determines the capital investment and the position size on the basis of the maximum loss to be accepted!
Since capital loss can only be compensated by a corresponding higher profit, a good money management is essential!
Enclosed are a few values to get a feeling for losses:
A loss of -20% needs +25% recovery to get back to the old price level.
A loss of -40% needs +67% recovery to get back to the old price level.
A loss of -50% needs +100% recovery to get back to the old price level.
(see also the Tesla -70% example needs +233% performance!)
If one risks per position only 1% of the available capital, then even after 10 wrongly estimated trades approx. 90% of the capital would still be available. If one would risk 4% of the available capital per position, then one would have lost already 40% of the capital after 10 wrongly estimated trades, i.e. one would need already +67% performance on the remaining capital, in order to recover only the starting capital.
An established guideline for money management is - never risk more than 0.5 to 2% of your capital for a single position.
Money management is primarily concerned with how much money you should bet and risk per position! It is about determining the optimal position size.
To make what is described here a little more tangible, here is an example of how to calculate a position size.
Your free capital for investments: 10.000€.
Your maximum loss limit per position: 1% (= 100€)
You want to build a position with current purchase price 20€ per share
Your determined stop price is 18€ (= max 2€ per share loss)
The optimal position size is now calculated by dividing the maximum loss by the difference between the purchase price and the stop price.
Optimal position size = 100€ / (20€ - 18€) = 50 shares
See also picture2 - My template to calculate the lot size or the SL
This means for you, with a position size of 50 pieces and a stop price of 18€ you stay within the maximum 1% loss according to your money management. Now you just have to stay disciplined and do not deviate from your strategy.
Sounds easy, but it's not - that's where it usually fails in practice 😉
Conclusion:
With a consistent risk management through diversification and defined exit points, combined with money management, you can consciously limit your losses. In the stock market you can't really influence most factors, the only thing you really have in your hand is your entry and exit price combined with the optimal position size.
PS: Since this is my first knowledge post on GQ, please let graciousness prevail! Remember, I am not a FinFluencer, constructive criticism is welcome! The whole thing is not investment advice, I'm just telling you about my personal approach here!
For those who are interested, there is a practical example in the 3rd section.
3. money management in practice
I will not go into the selection of the company here, there are already some great articles on key figures, fundamental analysis and TA technical analysis. For short-/medium-term trades, the CRV (risk-reward ratio) is always an important decision criterion for me.
Regarding free capital, the following goal has crystallized for me during the first months of 2022: Due to the ongoing bear market, no more than 20,000€ should be invested in my portfolio in 2022. A part of the monthly available capital will be saved successively as "free cash reserve for 2023". Quasi self-protection against FOMO (Buy the dip from the dip from the dip...)
Company: OMV
As an Austrian and especially in the course of the current discussions around energy prices and excess profits, I had OMV already the whole year "in the eye". At <37€, the price was in the range that was interesting for me for a trade. As a target price / exit point I have the price level of 50+ for me definier, because the OMV has held the last few years rarely longer above this price level. (see also Figure3 - 5 year chart OMV).
Money Management - Calculation of the optimal position size:
Free capital for my 2022 investments: 20.000€
1% max. loss per position: 200€
Buy price / entry price <37€ / StopLoss -15 (31,45€) =
5,55€ max. loss per share
The optimal position size is as follows: 200€ / 5,55€ = 36 shares max. position size
(Attention: if you have relevant purchase/sale additional costs, these costs have to be considered)
To minimize the risk even more, I often enter with 2 or more tranches. If the price runs away from me, then the trade runs with a smaller volume.
Buy1 15 pieces on 23.09. a' 36,15€
Buy2 15 pieces on 12.10. a' 36,86€
Sale 30 pieces on 9.11. a' 48,57€
SL was set quite narrowly with -3.5% when entering the area above 50€.
If the price had fallen below 31.45€, I would have sold the position with the defined loss. According to my money management, the maximum loss would have been limited to less than 1% / 200€. In this case, due to the slightly smaller position size, the maximum loss risk was not exhausted (30*5.55€=166€).
Conclusion: Realized return of 33% with limited loss potential of maximum -15%. Since of course not every position can be closed with profit, the whole thing works only with appropriate discipline and consistency.
Source references: Well, I have a bit of a hard time with that, I have read up on the topic over the last few years from various sources, mostly from the Internet, blogs or Youtube. Many knowledge articles of this kind can be found in the knowledge databases of your brokers. Just search for money management. Enclosed are links where I found something on this topic today.
Risk- und Money-Management Analyse : Wiener Börse (wienerborse.at)
Risiko- und Money-Management | comdirect Magazin
Gutes Money Management: 4-Schritte-Anleitung - Sofort-Start? (aktien-lernen.de)
Moneymanagement - die Grundlagen! (Teil1) | stock3
