Overtrading-putting on trades that are too large for your account-is a deadly mistake. Beginners are in a hurry to make money, whereas serious traders begin by measuring risks. If you start small and con centrate on quality, you'll become a better trader. Once you've learned to trade-find trades, enter, set stops and profit targets, and exit-you can start increasing your trading size to the point where your account starts generating a meaningful income.

A new trader came to see me recently, a 42-year-old businessman tired of the rat race. His wife continued to run their business, while he put all his time and energy into the market. He kept bobbing around breakeven, trading anywhere from 100 to 1,000 shares at a clip. Often, he'd make money on several trades in a row trading small lots and then give back everything on a single large trade.

I told him he was ahead of the game because, unlike most beginners, he hadn't lost money. I then gave him the standard prescription- begin by trading 100 shares, the smallest round lot, until you have a profitable period during which you have more winners than losers and are profitable overall. That period should be two weeks for a daytrader or two months for a longer-term swing trader. Once you have had a profitable period, bump up your size by 100 shares and start trading 200. After another profitable period, go up another 100 shares and start trading 300. If you have a losing half-period (a week for a day-trader, a month for a swing trader), go back down to your previous trade size and start counting again. If you trade futures, substitute one contract for 100 shares. Advance slowly, retreat fast.

In his ground-breaking book Portfolio Management Formulas, Ralph Vince introduced the concept of the optimal f-the optimal fraction of your account to risk in any given trade for maximum long-term gains. His book is mathematically demanding, but it boils down to a few key concepts: there is an optimal f for every trade; if you bet less, your risk decreases arithmetically while profit decreases geometrically; if you keep betting more than the optimal f, you are guaranteed to go broke.

The optimal f keeps shifting with every trade and is hard to calculate. It provides the highest returns in the long run, but it also leads to vicious drawdowns that may exceed 90% of the account. Who has the fortitude to continue trading a system that has brought his account down from $100,000 to $9,000? The main value of the optimal f is simply to remind us that if we trade a size that's too large, we'll destroy our account. The optimal f marks the zone beyond which you walk into a minefield. Stay away from it, trade less than the optimal f.

Beginners who count profits put their cart before the horse. Reverse that approach and begin by counting risks. Ask yourself what your maximum permitted risk is if you follow the 2% and 6% Rules.

These are the steps of proper money management:

1. Measure your account value on the first of the month-the total of cash, cash equivalents, and open positions.

2. Calculate 2% of your equity. This is the maximum you may risk on any given trade.

3. Calculate 6% of your equity. This is the maximum you are permitted to lose in any given month, after which you must close out all trades and stop trading for the rest of that month.

4. For every trade, decide on your entry point and a stop; express your risk per share or per contract in dollars.

5. Divide 2% of your equity by your risk per share to find how many shares or contracts you may trade. To get a round number, round it down.

6. Calculate your risk on all open positions by multiplying the distance from the entry point to the current stop by the number of shares or contracts. If the total risk is 4% of your account or less, you may add another position, since you'll be adding 2% with your current trade, bringing the total to 6%. Remember, you do not have to risk 2% per trade; you may risk less if you like.

7. Put on a trade only after meeting all of the above conditions.

Establish the size of your trades on the basis of how much money you can afford to risk, not how much you want to make. Follow the 2% and the 6% Rules. If you are having a good month, with most trades going your way, you will move your stops beyond breakeven and will be allowed to put on more positions. You may even go on margin. The beauty of this money management system is that it clips your losses when you are cold and lets you go forward at full throttle when you're hot.

On the first of the month, if you have no open positions, the 2% and 6% levels are easy to calculate. If you approach the first of the month with some open positions, calculate your account equity-the value of all open trades at the latest market price plus all cash or money market funds. Calculate the 2% and 6% levels on the basis of that number. If you have moved stops beyond breakeven in open trades, you have no capital at risk and may look for new trades. If your stops are not yet at breakeven, find the percentage of your equity you have exposed to risk and count it against the 6%. Once you deduct that number from 6%, the result will let you know whether you may put on new trades.

How should you apply the 2% and 6% Rules if you trade futures, stocks, and options all at the same time? First of all, a beginner should concentrate on a single market. Diversify only after you succeed. If you are trading more than one market, open separate accounts and treat each as a separate trading enterprise. For example, if you have $60,000 in stocks and $40,000 in futures, calculate the 2% and 6% Rules for the $60,000 and apply them to stocks, and then calculate the 2% and 6% Rules for the $40,000 and apply them to futures. If you have more than one account, allocate trading-related expenses in proportion to their sizes.

Remember, both your trading system and your money management must be good in order to win in the markets.