Three rules to protect your wealth

One skill is more important to successful trading than any other disciplined money management.

Spread betting is riskier than standard share trading. That's because you are effectively borrowing money to trade the markets. So if you're not careful, one bad bet could easily wipe out your entire starting capital (and more) thus ending your trading career before it's begun.

Good money management is about avoiding exposing yourself to this scale of risk in the first place. This involves the prudent use of stop-loss orders to manage risk of loss.

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Although some traders do not use stops, I think they are crucial. If you follow my trades on my blog, you will see that I adjust my stops as the market allows, to protect any gains, and to further reduce the risk of loss.

The good news is that effective money management isn't complicated. The skill lies in sticking to it, and not getting carried away by a run of good luck, or panicked by a string of losses.

I have three money management rules:

The golden rule

Preserve your account equity the money you started your account with (in my case, £4,000). How do you do that? By always following my other two rules.

The 3% rule

Never risk more than 3% of your capital on any one trade. So I will always have a stop-loss in place in order to avoid losing any more than 3% of my capital. For example, starting my account at £4,000, the 3% maximum loss is £120, or 120 points on the FTSE 100 or Dow Jones on a £1 bet. So you would set a stop-loss to kick in as soon as (or before) your losses mounted to £120.

The break-even rule

Move your protective stop-loss to break-even as quickly as possible. In other words, once your trade has moved sufficiently into profit, move your stop-loss so that if the move is suddenly reversed, you get knocked out at breakeven. This is a judgment call there is no hard-and-fast formula that can be stated.

The fact is, no trader gets it right 100% of the time, or anywhere close. Losses are to be expected. So what really separates those who make money in the long run, from the rest of the herd, is that they are able to avoid ruinous losses and so live to trade another day.

How do you know what to bet on?

So how do you find a promising trade? I use a mixture of classical technical analysis and some methods of my own. To be more specific, I pay particular attention to Elliott wave analysis and Fibonacci numbers. You can learn more about these at www.moneyweek.com/SB, but they are essentially ways of pinpointing price points where a market is likely to change direction.

The Fibonacci sequence of numbers, where each number is derived by adding the previous two numbers (so it's 1,1,2,3,5,8... and so on) occurs regularly in nature, and often you'll find that markets advance and retrench in movements that reflect the Fibonacci sequence. Elliott Wave theory, meanwhile, is useful for spotting trends and counter-trends, and estimating where they will change direction.

Technical analysis is sometimes derided as mumbo-jumbo, or an attempt to impose some sort of pattern where there's none to be found. This is a particularly prevalent view among those who are relatively new to investing and to 'value investors'. All I'd point out is that, while I believe absolutely that you should have a 'fundamental' view on the economic outlook, the fundamentals don't help you with timing. As far back as 1996, people were warning that tech stocks were overvalued. Were they right? Pretty much. Did they make any money? No.

If you're still sceptical, I'll just point out that Britain's most successful mainstream fund manager, Anthony Bolton, has said in the past that if he could only access one piece of information about a stock or market, it would be a price chart. So I'd encourage you to suspend your disbelief, and keep an open mind. You may well be surprised.