Above All, Focus on Money Management

That's how you will realize your greatest trading gains, Gary B. Smith argues.
Publish date:

In my

column last Wednesday, I concluded my discussion of

Burton Malkiel

by emphasizing that without knowing a technician's money-management scheme, it is impossible (read: ludicrous) to pass judgment on the worthiness of chart-reading -- or, in fact, technical analysis in general.

Or let me say it this way: If I showed you chart XYZ but you didn't know where my entry and exit points were, you could reasonably conclude that chart-reading was nothing but hokum ... or that I had a crystal ball.

As an illustration, let's look at a chart of



-- in fact, the one I used on a recent episode of "TheStreet.com" on

Fox News Channel

. I'll show three different money-management setups, one which resulted in a loss and two which resulted in wins.

Now, of course, I could have come up with an infinite number of limit and stop targets, ranging from the ridiculous to the well planned. It really doesn't matter, though, because the point is that the money-management schemes are what make or break the chart!

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In other words, was my call to go long Yahoo! the day after the show right or wrong? Or, in a broader sense, does relying on charts give you an edge in your trading or not?

Well, it all depends, doesn't it? Those folks who went with the GBS 5/6 target/stop setup had a loser on their hands. Other traders had a quick winner. Still others had a huge winner. And, of course, there were thousands of groups in between that had anything ranging from scratches to solid gains.

So, to come back to Malkiel's basic tenet, can you now see how impossible it is to judge his statement -- "The central proposition of charting is absolutely false" -- without knowing the money management involved?

But enough about the good professor. Let me go even further and give you an assignment for the rest of this year that will make a huge difference for you in 2000.

Go back over a representative sample of your recent trades. The more, the better, of course, but you won't need a lot to make some headway.

Now, within those same trades, assume your entry point was exactly as it was initially. But now, go through and change your target and/or your stop. It doesn't matter if your results get better or worse, because what should happen is this: With the same exact candidates and the same exact entries, your results will swing dramatically up and down just by varying your money management!

As an example, you might find that by lowering your limit target, you have a lower gain per trade but a far greater number of wins, thereby greatly increasing your profits.

Or you lower your limit target and find your higher number of wins only cancels out your lower gain per trade ... but that you now close all your trades quicker, thereby allowing you to perform more trades per year. And this greater number of trades per year generates a greater number of profits!

Look, this stuff gets messy and complicated if you're just talking about it, but it should be clear and precise if you just take pencil to paper.

So my point is this: Chart-reading matters. Picking the right candidate matters. But you will realize your greatest gains by focusing on money management. That's where you should be spending your time next year. I hate to say it, but everything else is secondary.

Gary B. Smith is a freelance writer who trades for his own account from his Maryland home using technical analysis. At time of publication, he held no positions in any securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Smith writes five technical analysis columns for TheStreet.com each week, including Technician's Take, Charted Territory and TSC Technical Forum. While he cannot provide investment advice or recommendations, he welcomes your feedback at