SCOTT WELSH TRADING BLOG

What’s More Important: The System or Money Management?

What’s More Important: The System or Money Management?

Nov. 27, 2019

How long have you been killing yourself trying to find a system?

For me, it’s been over 15 years.

Even when I’ve gained wisdom, even when I see the research, I still think I can do better.

I still think there might be something magical out there.

And maybe there is.

Or maybe there’s not.

Maybe the way for regular people to make it big is not in exhausting ourselves in research.

Maybe we already have what we need, but we have been looking the wrong way.

Maybe money management is the most important thing.

Isn’t that scary if it’s true? What if I’ve been wasting all my time all these years trying to perfect a system that never really needed perfecting in the first place?

What if a simple system is all I ever needed and I’d be a billionaire by now if I’d only used proper money management.

That’s what we’re talking about this week.

Is it the system or is money management?

First, though, we need two quick definitions. We need to choose and define a simple system and we need to define what money management is.

Here’s what we’ll use for a system.

Even though I like indicators, the best trigger might be to use indicators in a different way. Specifically, the best entry might be when price is divergent.

What does divergent mean? It means price makes a higher high but an indicator does not. For example, Apple hits a new high. Shouldn’t Stochastics or RSI or CCI also make a new high if the trend is strong? Absolutely.

But what if the price is going higher but the indicator is going lower? That means the move has no strength, and it’s going to probably topple over the other way.

That’s divergence. And I’ve found it to be a pretty powerful tool.

So that’s our system. We’ll wait for price to be divergent, and then we’ll enter at the open of the next bar. We’ll have a stop and a target. We’ll use a 4-hour chart also because divergence is much stronger on longer-term charts (240M or Daily).

And that’s it.

Here’s a summary of our generic system:

  1. Use a 240M Forex chart (hopefully one that moves!).
  2. Wait for divergence.
  3. Enter at the Open of the next bar.
  4. Wait for our trade to hit the profit target or get stopped out.

We’ll need a divergence indicator, though, so we’ll use my friend Rob Booker’s Knoxville Divergence (see a demo here.)

On the chart below, Knoxville Divergence (KD) will appear as a line above or below price. If KD is above the bars, it’s bearish and we will go Short. If it’s below the bars, it’s bullish and we’ll go Long.

You can use any sort of divergence you like. It should be similar.

Here’s a picture of a sample trade:

The opposite is true for Short trades.

I chose AUDJPY only because I thought it might move. Trading 1 lot each time on a hypothetical $20k account, it made $32, 247 with a max drawdown of $24,831. The target was $2,200 and the stop was $6,200. I did almost no optimizing.

Not great, right?

If we saw these numbers, we’d just move on and not give it another thought.

Or we’d dive in and try to make this system much better.

But is that really what we should do?

In our next email, we’ll put some money management on it and see what happens. Can money management make a mediocre system better?

Talk to you soon.

 

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Disclaimer:
It should not be assumed that the methods, techniques, or indicators presented in these products will be profitable or that they will not result in losses. Past results are not necessarily indicative of future results. Examples presented on these sites are for educational purposes only. These set-ups are not solicitations of any order to buy or sell. The authors, the publisher, and all affiliates assume no responsibility for your trading results. There is a high degree of risk in trading.

HYPOTHETICAL OR SIMULATED PERFORMANCE RESULTS HAVE CERTAIN INHERENT LIMITATIONS. UNLIKE AN ACTUAL PERFORMANCE RECORD, SIMULATED RESULTS DO NOT REPRESENT ACTUAL TRADING. ALSO, SINCE THE TRADES HAVE NOT ACTUALLY BEEN EXECUTED, THE RESULTS MAY HAVE UNDER- OR OVER-COMPENSATED FOR THE IMPACT, IF ANY, OF CERTAIN MARKET FACTORS, SUCH AS LACK OF LIQUIDITY. SIMULATED TRADING PROGRAMS IN GENERAL ARE ALSO SUBJECT TO THE FACT THAT THEY ARE DESIGNED WITH THE BENEFIT OF HINDSIGHT. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THOSE SHOWN.