I see these two terms everywhere. What is the difference between the two, I usually see them together, and to me they seem one in the same. However, they must be different, what does each do, and which should I be focusing on?
These terms are somewhat subjective, butâŚ
Money management is a term used often in the trader community. It involves deciding how large a position to take on trade entry, how to scale into or out of a position, etc. It also involves setting aside enough capital that you can make more than a few mistakes and still not blow up. Sometimes it involves averaging in when price goes against you (very dangerous), other times it involves taking profit on part of a position and keeping the rest of the position in case you have a ârunnerâ. Done well, money management can amplify the value of your entry/exit signals.
Risk management is more of an institutional term. It involves statistical models for such metrics as VaR (value at risk), CVaR (conditional value at risk) and many others. Risk managers at banks, hedge funds, brokers, etc. will estimate portfolio risk across managers, across instruments, etc. to comply with financial regulations, and to reduce the chance that theyâll be exposed to deep losses in case of a big event in the market. They will also look at subjective things like counterparty risk, technical risk, model misspecification risk, etc. etc. In this sense, Risk management attempts to manage all the material risks a firm faces. Easier said than done!
Money management is the way you allocate funds across the portfolio(s) of instruments and strategies. In the most simple case itâs the way you evaluate the trading size for the next trade. Risk management is the set of ways to control risk, not only systematical, but also human, software, hardware, etc. Normally it involves stop orders and methods that ensure their proper execution, along with fat fingers limits, margin check, routine maintenance procedures and so on.
MONEY MANAGEMENT
To properly manage your Money, you would need a âSystemâ or âFormulaâ that will enable you to decide your Lot Sizes. In other words, itâs about how many Lots to trade for every single trade you are thinking of executing. Having a system in place, will then allow you to take the âEmotionsâ out of trading as well as reduce risky intentions in using âinstinctsâ or âgut feelingsâ to make financial decisions.
RISK MANAGEMENT
Managing oneâs Risks is directly related to an individualâs âRisks Toleranceâ. In order to manage your Risks better, you would need to be aware of the impact your trades will have towards your remaining equity of the account as a trader before either getting a Margin Call or being Stopped out. Therefore, in Risk managing of any trade could be measured based on the percentage of your account you are willing to risk, if the trade goes against you.
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But donât you think that managing risk while trading is a part of money management?