Once upon a time there were three little pigs, Porky, Pinky, and Pete each with a trading account. . .

Porky

Porky loved the thrill of the markets, the excitement of the up's and down's.  During the dot com boom, Porky would buy a stock at market price and watch the price go higher.  He would eventually sell the position, and then watch the prices go even higher, this made him feel bad, and he got mad at himself. 

Other times, Porky would buy into a position and it would go against him.  His two brothers would ask him, what are you going to do?  His reply was, "don't worry they always come back" or "I believe in this company" or "so and so just recommended them, I'm in it for the long haul."  

So time went on and Porky's account grew, it doubled, then tripled, then porky quit is job and decided he was smart enough to go full time.  some more time went on and Porky just watched CNBC and placed his orders, everything was fine until one month all of his positions were down.  

"What are you going to do?" said his brothers, "Nothing!" Porky Replied, "these companies are solid, and they are going to come back eventually.  I'll wait it out if I have to!"  And wait he did, a few months went by and Porky assured himself that everything was ok, a few more months went by and Porky had trouble sleeping.  Eventually Porky was feeling a tremendous amount of pain from his account activity.

Porky figured the best thing to was to double up on some of his positions, so he would be able to make up his losses even faster when they turned around, so he put the rest of his account in the market.  At this point Porky was a wreck, he couldn't eat, sleep, or enjoy any of the fun that life had to offer, the market was going against him and he was taking major losses.

Pete came by one day and asked Porky when he planned on cutting his losses and getting out, Porky replied "I cant sell now!! are you crazy, look at how much my positions are down, do you know how much I will lose if I sold?!  I have to wait this thing out, they will turn around eventually, they always have."

A few weeks later, Porky heard a knock at the door, it was his broker, he had a margin call.  Porky had all of his savings in the market, and no income to boot.  His broker liquidated the account and Porky was sent to the slaughter house and turned into bacon.  Porky's money management was made of straw.

Pinky

After watching all of this happen, Pinky decided he was going to do things much different than his brother Porky.  He had heard of things like stop losses and money management and was sure that the was not destined to share the same fate.  He subscribed to investing magazines and read the business section of the paper almost every day, watched the news and tried to keep up with most current events.   Pinky had been trading a bit longer as well and felt that he was a bit more accomplished and even considered him self a sophisticated trader.

Pinky only had a few positions open at a time, depending on how comfortable he felt with the market conditions.  He did not have the same tolerance for pain so when positions started to move against him he would give them a little room, but exit when the pain became too much he would take his loss.  Porky also felt bad when taking a loss and would always say, "It always seems that I sell at the low," and, "The market knew where my stop was."

Pinky also had winning trades, sometimes he would watch a position be up big, then turn around and he would have to sell at a loss, soon Pinky had the saying, "You can never go broke taking a profit."

Pinky's continued this style of trading for some time, he didn't keep very good trading records, so the only time he was able to analyze his trades was when his broker sent him a quarterly statement.  One day Porky noticed that his account had it's up's and downs, but overall was falling in value each year.  

Pinky didn't understand what he could possibly be doing wrong, he figured he should start taking larger positions so the winning trades would help increase his account.  After making the adjustment, Pinky felt pretty good, he had a couple of winning trades and his account was headed in the right direction.  

The first position that started to move against him really made him nervous, he was anxious about selling at a loss, he had never taken such a big loss, he would say things like, "I'll give it another day" and "if I sell now, all of my winnings will be wiped out."  Pinky knew he couldn't handle a bigger loss, so he eventually sold, taking the loss.

After a few months of similar activity, Pinky became mad that "the market was out to get me."  He spent countless hours studying the balance sheets of companies before he would invest, he felt that if anyone was to make money it was him, he thought there was a direct correlation between lot's of research and profitability.

Once in a while Pinky would find what he thought was a "diamond in the rough." He would place a large amount of his account in the position, sometimes he was right, sometimes he was wrong.  Still his account overall was shrinking.  So one day he concluded that he had found the next big thing, and decided he was going to put a very large position into it and "ride it to the top."  

Within a few weeks news had come out against his position and he was devastated.  his account was now at a fraction of what it started out with.  He was disgusted with the markets, and felt that if someone as smart as him couldn't make money, than no one could.  The next time he heard from his broker, he closed his account with what he had left and was sent to the slaughter house and turned into ham.  Pinkys money management was made out of wood.

Pete

Pete was the oldest of the three brothers and knew there was a better way,  he knew there were people who consistently made money in the markets and that if he did the same things that they did, he too would be profitable.

Before opening an account with his broker, Pete went online to www.tradingwithmoneymanagement.com and spent months studying all of the different topics.  He quickly learned that there was much more to being successful than just having good entries.  He learned ways to study his trading system and quickly realize if over time it was going to provide a profit or loss based on it's expectancy.  He learned about the 2% rule and position sizing, so when he was wrong about the market, (and he was wrong quite often) he would get out quick, without any emotional pain and with very little damage to his trading account.

Pete started using limit orders and shopped around for the brokers with the best prices, and learned about slippage and just how big of a hidden cost that is to a trader.  Pete was not the smartest of his brothers so he decided to keep his trading system very simple, he was a busy pig and didn't have too much time to spend on his trading activities.

Pete than learned that you can apply money management to your entire account and not just each specific trade.  He learned that different systems were needed depending if you are using a trend following system or a counter trend system.  

Pete had a written plan that he could follow so there was no need to make any decisions along the way, when the position has already been open.  He decided he would judge his performance on how well he was able to stick with his trading plan, that way he would be able to create a level of consistency and make improvements along the way.   

Once Pete opened his account, he started to put on his trades, right out of the gate he had 5 losses in a row, but looking at his account balance, he felt fine.  His losses were controlled and his first winning trade put him ahead.  He never felt out of control, as he had a plan set out for every single possibility that could happen.

Pete didn't get very much emotional satisfaction from trading, he felt is was almost boring, it was a very mechanical procedure with nothing left to chance.  Pretty soon he was almost able to predict how his account would look at the end of the year with it's up's and down's.  He had to look to other areas of his life for thrills.

Pete's account continued to grow, he would then increase his position size appropriately and it would grow some more.  Pete kept extremely organized records of his trading and was able to identify if anything seemed to be out of the normal flow.  When it was he made adjustments to his trading plan and continued.

One day Pete's Broker asked him, "How is it that you can trade these crazy markets and make money each year?"  Pete replied, "In a nutshell, you must learn how to control your risk based on your personality, and account, then you must have a system that can be followed and executed at all times, additionally you must let you profits run."  "I know all that!" said the broker, "I tell my clients that sort of stuff all the time, but almost all of them still get sent to the slaughter house."

"knowing something, and understanding something are two completely different things." said Pete, "everyone knows that an engine is what allows a car to accelerate and take you where ever you want to go.  But how many people understand exactly how it works and why?  This understanding will take you to a new level and allow you to be successful regardless of outside conditions, because you will be able to adapt your engine to the current conditions."

His broker agreed and now takes out Pete out every 2nd Tuesday to play golf while learning more about money management.  Pete's money management is made of brick.

 To Fully Understand this Key Concept read The New Money Management