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5. Technical Analysis > The Importance of Money Management

The Importance of Money Management

In technical analysis, money management means balancing risk and return [Hack #37] : determining how much risk you’re willing to accept, and managing the trade positions you undertake to control your risk and protect your profits. Because technical and fundamental analysis both evaluate past performance to try to forecast the future, the success of technical trades and fundamental investments are by no means guaranteed. Traders and investors who are successful over the long term know that going for broke is usually a self-fulfilling prophecy, so they share a common characteristic of disciplined actions to protect themselves from trades and investments that turn sour.

Spectacular wins can clearly turn a small portfolio into a fortune. The danger is that disasters don’t have to be nearly as spectacular to wipe out the gains. For example, if your portfolio drops by 20 percent, you might think you need only a 20 percent return to get back on track. Not so. Consider a portfolio of $100,000. If it drops 20 percent to $80,000, you need 25 percent ($20,000) to get back on track. By the same calculations, you need a 100 percent gain to recover from a 50 percent loss. Unfortunately, 50 percent losses seem much easier to come by than investments that provide 100 percent gains. So, protecting your portfolio from losses is a key to success.


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