Do you trade for the money or for the thrill? Don't tell me, just show your trading records. Don't have good records? Well, that's an answer in itself. If you keep records, then the slope of your equity curve will show how serious you are about trading.

Most people enter the markets for the money, but soon loose track of that goal and start chasing some private version of fun. The trading game is a lot more interesting than solitaire and feeds dreams of wealth and power. People trade to escape boredom or show off their smarts. There are as many neurotic reasons to trade as there are traders, but only one realistic one-to make more money than from riskless invest ments, such as Treasury bills.

Successful trading is based on 3 M's: Mind, Method, and Money. Mind is trading psychology, Method is market analysis, and Money refers to risk management. This last M is your ultimate key to success. The slope of your equity curve, which you must draw as a part of your money management process, reflects the state of your mind as well as the quality of your method.

Anyone can make money on a single trade or even several trades. Even in the casinos of Las Vegas you continuously hear the music of the jackpots. Coins pour from the slot machines, making a happy noise, but how many players go back to their rooms with more money than they came with? In the markets, almost anyone can make a good trade, but few can grow equity.

Money management is the craft of managing your trading capital. Some call it an art, others a science, but really it is a combination of both, with science predominating. The goal of money management is to accumulate equity by reducing losses on losing trades and maximizing gains on winning trades. When you cross the street after the "Walk" sign lights up, you still glance right and left because some crazed driver may be barreling toward the crosswalk, sign or no sign. Whenever your trading system gives you a signal, money management becomes the equivalent of glancing right and left. Even the most beautiful trading system requires money management to make consistent profits.

I once met a father and son team of successful money managers. The father began grooming his son for the business while the boy was still a teenager. On weekends he used to take him to the track and give his son $10 for the day. That was his lunch money and betting money. The father spent the day with his cronies, while the kid could come up and ask questions but never got another dollar. He had to make his money betting horses and manage his resources if he wanted to eat lunch that day. Learning to handicap horses (technical analysis), manage his stake (money management), and wait for the best odds (psychology) paid off a million-fold after the son joined his father in managing a hedge fund.

A good trading system gives you an edge in the market. To use a technical term, it provides a positive expectation over a long series of trials. A good system ensures that winning is more likely than losing over a long series of trades. If your system can do that, you need money management, but if you have no positive expectation, no amount of money management will save you from losing.

For example, a roulette player has a negative expectation. A roulette wheel has 38 slots in the United States and 37 in Europe, but only 36 are in play, as the house "owns" the remaining one or two. Since a slot represents roughly 2.7% of a wheel, over a period of time the house skims that much from each game, slowly bleeding players dry. There is a primitive money management system called a martingale that has players start with a minimum bet, usually $1, and double up after each loss, so that in theory, when they eventually win, they get back all they lost plus $1, and start with $1 again. Martingale does not work in real life because casinos limit maximum bets. Once your loss runs up to that limit, a martingale just hits its head on the ceiling and dies. In blackjack, on the other hand, a very disciplined trader who follows a tested strategy and counts cards has a slight edge over the casino, on the order of 1 or 2 percent, sometimes higher. Here a good card counter needs money management to keep bets small on iffy hands and double up on strong hands.

Once you have a trading system with a positive expectation, you must establish money management rules. Follow them as if your life depended on them, because it does. When we lose money, we die as traders.

Whatever percentage of capital you lose, you must make a greater percentage to come back. I used to carry a receipt from a car rental agency to illustrate this point. The receipt showed a charge of $70, followed by a 10% discount, and 10% tax. What was the bottom line? If you said $70, go back to the books! $70 - 10% = $63. $63 + 10% = $69.30. If 10% is taken away and 10% added, you end up below the starting point. Losing equity is like falling into an ice cave-it's easy to slide in but hard to claw your way out because the edges are slippery. What happens when a trader knocks his $10,000 account down to $6,600? He's down 34% and must make 50% just to come back to even. How likely is it that a trader who just dropped a third of his equity will earn 50%? He's at the bottom of an ice hole. He'll either die or get a new lease on life from an outside source. The key question is whether he learns from his experience.

Markets are about as soft as a gladiator fight. Life on the battlefield is measured in money. Everybody's fighting to take it away from you-competitors, vendors, and brokers. Losing money is easy; making it is hard.

Money management has two goals: survival and prosperity. The first priority is to survive, then to grind out steady gains, and finally, to make spectacular gains. Beginners tend to have those priorities reversed. They shoot for spectacular gains but never think about long-term survival. Putting survival first makes you focus on money management. Serious traders are always focused on minimizing losses and growing equity.

The most successful money manager I know keeps saying he's afraid of ending up as a taxi driver. His engineering degree is out of date, he has no work experience outside the markets, and if he fails as a trader, all he can do is drive a cab. He's made millions, but still does every thing in his power to avoid losing money. He is one of the most disciplined people I know.

NO MATH ILLITERATES

Modern society makes it easy to live without counting. Most of us rarely count, having grown accustomed to calculators and digital screens on appliances. If you can add up the number of guests at a dinner party or figure out how many beers are left in a six-pack after

you have drunk two, you're in good shape. It's easy to go through life with hardly any arithmetic. Not so in the markets.

Trading is a numbers game. If you cannot count, you cannot trade. You do not need calculus or algebra, but you must be on easy terms with basic math-adding, subtracting, multiplying, and dividing. In addition, you need to calculate percentages and fractions and round off numbers in order to count fast. Also, you must be at ease with the concept of probability. This may sound simple, but it never ceases to amaze me how poorly and slowly most beginners count. All good traders are on easy terms with math. They are practical and sharp people who quickly calculate risks, results, and odds.

What if you're a product of modern education and need a calcula tor to subtract 26.75 from 183.5 or figure out 15% of 320? You need to educate yourself. You have to drill yourself in arithmetic. One of the easiest ways to do so is by counting change when you go shopping. Estimate the total price. Once you give money to a cashier, calculate how much change you'll need. Figure out sales tax in your head. Keep practicing, keep stepping out of the comfortable shell of modern con sumer society where counting isn't necessary. Read a couple of popu lar books on the theory of probability.

Troublesome? Yes. Time consuming? For sure. Learning to count on your feet is not entertaining, but it'll help you succeed in trading. How wide is the channel? What is the ratio of the distances to your stop-loss and the profit target? If you want to risk no more than 1% of your account and the stop is 1.25 points away, how many shares may you buy? These and similar questions go to the heart of successful trad ing. Being able to answer them on the fly gives you a real advantage over the crowd of innumerate amateurs.

BUSINESSMAN ' S RISK VS . LOSS

Remember our example of a small businessman who ran a fruit and vegetable stand, selling several crates each day? What if his wholesaler offered him a crate of some new exotic fruit? He could make money on it, but if locals did not like the fruit and it rotted, a single crate would not hurt his business. It is a normal businessman's risk.

Now imagine he bought a tractor-trailer of that fruit at a super low price. If it sold, he could make a quick killing, but if that load rotted on him, it would hurt his business and could endanger his survival. A crate presented an acceptable risk, but a truckload was a rotten risk.

The difference between a businessman's risk and a loss is its size relative to the size of your account.

A businessman's risk exposes you to normal equity fluctuation, but a loss threatens your prosperity and survival. You must draw a line between them and never cross it. Drawing that line is a key task of money management.

Whenever you buy a stock and place a stop under it, you limit your dollar risk per share. Money management rules limit your total risk on any trade as a whole, allowing you to risk only a small percentage of your account. If you know your maximum permitted risk per trade as well as your risk per share or contract, it is a matter of simple arith-metic to calculate how many shares or contracts you may trade.

Money management rules are essential for your survival and success. Few traders have the discipline to follow them. Promises are easy to make while reading a book, but wait until you are in front of the screen. "This time is different, it's free money, I'll give this trade a little extra room." The market seduces traders into breaking their rules. Will you follow yours?

I was recently invited to chair a panel on market psychology at a gathering of money managers. One of my panelists had nearly a billion dollars under management. A middle aged man, he started in business in his 20s, while working for a naval consulting firm after graduate school. Bored with his job, he designed a trading system but did not have enough money to trade it because it required a minimum of $200,000. "I had to go to other people," he said, "and ask them for money. Once I explained to them what I was going to do and they gave me money, I had to stick to my system. It would have been unconscionable to deviate from it. My poverty worked for me." Poverty and integrity.

If you want to trade, you have to accept risks. A nitpicker, obsess ing over dimes, is too stiff to place orders. While you accept risks, you may not accept losses. What is the definition of a loss?

A loss is a violation of the percentage rules - the 2% and the 6% Rules.

Markets kill traders in one of two ways. If your equity is your life, a market can snap it with a single shark bite, a disastrous loss that effectively takes you out of the game. It can also kill like a pack of piranhas, with a series of bites, none of which is lethal alone but which together strip an account to the bone. These two money management rules are designed to protect you from the sharks and the piranhas.