You Can't Discuss Money Management Too Much

Gary B. returns to a familiar theme, showing how it could have made the difference between a win and a loss on AOL.
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In Friday's

column, I talked about money management. You know the money-management-is-everything mantra. And while I emphasized just how important the topic is, I'm willing to bet that 99% of what I talked about fell on deaf ears. Yes, most of you read the column, thought about it for two seconds and then went back to your daily business.

But this isn't meant to scold you. I mean, it's just human nature: In this information-saturated age, it takes a few go-rounds for just about anything to sink in.

So, because I think it's such an important topic, I want to revisit it -- this time with a real example. And, at the same time, I want to address this missive from reader

R. Sacco

, who wrote in after my Wednesday special chart

column:

Now what would really be helpful is if you took those charts and updated them one day later with your usual readout. Then maybe I could start believing in some of this TA. No one ever comes back to explain what the heck happened to his or her analysis on a comeback like this! Will you be the first? I kind of doubt it.

Now, why exactly do I bring this email to your attention? And what exactly does it have to do with chart reading? Well, just about everything.

Therefore, let's focus entirely on the recent action in

America Online

(AOL)

to show how money management and chart reading must be totally intertwined in order for you to become a profitable trader.

If you go back to my Wednesday column, you'll recall I said, "Anything lower than 113, and it's uh oh!" Now, in looking at the chart, AOL did something that's not unusual: It dropped through the support level, righted itself, and then closed

above

the support level.

Given that situation, let's look at two scenarios where money management was the entire difference between a win and a loss.

Scenario one: sell stop at 112 7/8; 5% profit target.

Suppose you read my comments, agreed with me and decided to short AOL when it broke 113. To do that, you put in a sell stop at 112 7/8, selling short on the first uptick after AOL traded there. Looking at the one-minute chart below, it looks like the first uptick might have gotten you filled at 113. At worst, you certainly would have gotten filled at 112 1/2, so we'll use that number.

Now here's the important part. If you were emulating my money-management scheme (and this is not an endorsement by the way, just an illustration), you'd have set your buy-to-cover limit price at 106 7/8 and your buy-to-cover stop at 119 1/4 (5% profit, 6% stop).

Sure enough, less than 30 minutes later, AOL hits the limit target and you're gone with a tidy 5 5/8-point profit.

Scenario two: sell stop at 112 7/8; 10% profit target.

Let's assume the scenario above plays out the same way, but this time once you're filled, your profit target is a more aggressive 10%. However, you still maintain a 6% stop loss. Therefore, your profit target is now down at 101 1/4, with your stop remaining at 119 1/4.

Unfortunately, AOL halted almost precisely at 105, made a U-turn, then closed a bit above 120, handing you a net loss of 6 3/4 points.

So, same chart, same entry, but a win on one and a loss on the other. Therefore, if I was doing my post mortem for Mr. Sacco, was I right or was I wrong? Correct: It all depends on what money-management parameters I was using!

I hope the point I started making this past Friday is clear. Chart reading is fine, and as a technician, it's certainly my bread and butter. But it's only a tool, and often a minor tool, in profitable trading.

No, the real difference-maker is always your money-management methods. So if you're grinding away at trying to read charts as well as I do, forget about it. Shoot, most of you already read them a lot

better

than I do! Better or worse, though, I hope you can see it's all academic (queue the mantra theme): Money management is EVERYTHING.

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

gbsmith@ibm.net.