In many letters to editors of various magazines, as well as letters to our company, the question always arises about the proper terminology that an author has used. Also, many people aren’t sure about what the various "management" terms mean. In answer to several people’s request, we are going to give the descriptions of various terms, as well as the basics of how others use them. The confusion stems from the three terms: Portfolio Management, Money Management, and Trade Management.

Portfolio Management

Portfolio Management is the technique of assigning money to different investment products or different securities within the same product. Asset Allocation falls under this category. Benjamin Graham in "The Intelligent Investor" uses techniques such as this and describes moving assets between Stocks, Bonds, and Gold. Mutual Fund managers use various techniques for determining how much money should be devoted to any particular stock and what percentage of the entire portfolio is to be retained as cash reserves.

When looking at Portfolio Management strategies (and there are literally thousands of them) take into account that they can have very different goals in mind as well as many different philosophies behind those goals. More often than not you will see different strategies claiming to be designed for the same group of people. Here is an example of a Portfolio Management philosophy for one individual’s life:

30 Years Old:
70% Mutual Funds
20% Cash
10% Stocks

50 Years Old:
20% Mutual Funds
10% Cash
70% Stocks

70 Years Old:
20% cash
80% Stocks

The philosophy behind this is that at the beginning of an investment life (around 30 years old) that there is little funding for anyone to play with and so a conservative approach is taken to allow assets to build up over the years. This also leaves enough cash available for unseen emergencies. By the time they become 50 years old they have sufficient assets to start playing the market hard as the money in Mutual Funds and cash should be sufficient enough to defend against any real potential hardship. By the time they become 70 any potential long-term gains are viewed to be unrealistic for the life expectancy. Active stock ownership is encouraged since the cash and shares are usually easily distributed to beneficiaries when the time becomes necessary.

Philosophy #2.

30 Years Old:
30% Mutual Funds
10% Cash
60% Stocks

50 Years Old:
50% Mutual Funds
10% Cash
40% Stocks

70 Years Old:
80% Mutual Funds
10% cash
10% Stocks

The general philosophy behind this strategy is that while people are young (and most recoverable from financial stresses) that they should take their most active approach to acquiring immediate high gain returns. This acquisition phase of their life flows into the 50-year-old range with the assumption that since they have a significant portfolio by this time that they are now looking to protect some of it while still playing the market significantly. By the time they become 70 they are into an almost straight protection phase, assuring that their beneficiaries are well protected.

Both of these strategies have merit. Both are designed with sound principles. Both are designed with the same groups of people in mind. But they have very different approaches and very different outcomes. It would be more accurate to say that instead of one being better than the other, that one is better for a certain type of investor than another. Different people have different comfort levels, and the comfort level of one strategy may not be (usually isn’t) for all investors.

Portfolio Management is also the assigning and movement of assets between securities in a related field. So it you have 60% of your account in stocks, the way you manage your portfolio determines what particular stocks you’re in at any given time. The rules for this type of management are even more subjective than that of overall Portfolio Management, but is usually not as much of a problem as many (experienced) investors and traders have their own rules for determining what securities they are in (either by a trading system, fundamental information, or other method).

Money Management

Money Management is the technique of applying certain assets to individual securities at different times. Money Management techniques are broken down into two basic methods: Devotion Per Trade, and Devotion Per Condition.

Devotion Per Trade determines how much to devote to a position "at the beginning of the position". Different circumstances (usually available capital) determine how much should be risked on the position for that trade. Amounts are adjusted depending upon circumstances at the beginning of the position. An example of this in stocks would be to take a position of 1000 shares, then exit, then enter a position of 800 shares, then exit, then 1300 shares, etc. As the account size changes (due to the success or failure of the previous trade) then the amount risked on the next trade will change. This kind of method is frequently seen in "Fixed Fractional", "Fixed Percentage", and Ryan Jones "Fixed Ratio" money management methods.

It should be noted here that Money Management techniques in general can be difficult for stocks, due to the lack of significant hedging ability, and because the value increase of the underlying security directly affects how much is purchasable. I.e., 1000 shares of a stock may increase 20%, but it still only has the purchasing power of 1000 shares. To change the number of shares being added, enough has to remain in the account to suffer the difference. This is an area where commodities/futures trading is ideal, since as an account (or position) increases/decreases in value, the margin requirements for each contract remain relatively the same. This allows additional contracts to be purchased where additional stock shares typically could not.

Devotion Per Condition determines how much to "add on to an existing position". This is commonly known as "pyramiding" a position. This is also broken down into two types of techniques: Fixed Movement Addition, and Signal Addition.

Fixed Movement Addition involves increasing a position at fixed increments or percentage movements. I.e., an initial trade is entered with 1000 shares/1 contract for a specified price. For every $5.00 (or 5%, or whatever fixed parameter) move in the positions favor, an additional 1000 shares/1 contract is added on. As soon as there is a $5.00 (5%, etc.) movement in the opposite direction, then all positions are exited. All profits from all positions are in the account’s favor, except the last position that was entered. Basically, all of the gains of the successful entries should more than offset any losses that the last added position should incur.

Signal Addition involves increasing a position every time an entry signal is triggered before an exit signal is triggered. This type of system can be seen in traditional indicators like the Stochastic Oscillator, where two, three, or more buy signals can occur before an exit signal occurs. At every entry signal, 1000 shares/1 contract is added onto the existing position, and all shares/contracts are closed out at the first exit signal. This type of money management works well for mechanical trading systems that actually generate multiple entry/exit signals. (Note that if analyzing this type of approach using MetaStock, the System Tester cannot show multiple entry/exit positions. However, the Expert Advisor is capable of displaying the buy/sell/exit symbols for multiple entries/ exits.)

Something to be aware of here. Many people have been brought up with the false notion that Money Management will turn a bad or mediocre system into a profitable one or that Money Management in and of itself is a trading system. This is false and will cost you dearly to find out. Money Management will make a failing system fail much faster, and a mediocre system almost random in the profits and losses, effectively turning it into a failing system. However, proper Money Management can typically turn a somewhat profitable trading system into an extremely profitable system, typically magnifying the returns multifold.

Trade Management

Trade Management is the art of risk protection of a trade. This is done by several techniques in a predetermined order. First, the trading system (entry rule, fundamental criteria, etc.) is analyzed to determine the basic risk of taking the trade. This analysis typically consists of:

Risk of Ruin
Ratio of winning vs. losing trades
Ratio of winning trade profits to losing trade profits
Largest expected drawdown
Etc.

Once the initial risk of the trade is evaluated, then the conditions to enter the trade are determined. These could be market orders, stop orders, limit orders, etc. This assures that the trade is entered at only the anticipated price or set of conditions. Along with an entry order, an exit (stop) order is simultaneously entered on the condition of fulfillment of the entry order. This is your initial stop-loss to prevent unforeseen adverse market activity. If the position moves favorably, then each day the stop-loss order is reevaluated and typically moved up to lock in profits (a trailing stop). All of these individual actions combined make for good trade management.

Which ones matter?

The simple answer is that all of them are important. If none of the management processes are being applied then an individual is closer to gambling than to investing or trading. Portfolio Management and Trade Management are used to protect capital, and Money Management is used to increase capital. Often, these techniques can be the difference between being a common trader and being a successful one.