I see too many traders putting on positions that are far too large. This tends to lead to emotional selling decisions, as the swings in a large position's value create greater internal reactions with any trader.

The reality of proper money management is that if you have a system with a positive expectancy (meaning you have an edge which allows you to pull profits out of the market over time), then you should ideally place many small positions to let your edge play out over a large sample size.  Look at the analogy of the big casinos in Las Vegas.  The house wants to let its edge play out by many small bets.  The longer you sit at a betting table, the greater the odds that the house will win and you will lose. (Did you know that 9 of the world's 10 largest hotels are in Las Vegas? How do you think they had the money to build all of those billion-dollar properties?)  In contrast, when you have a negative edge, if you had to place a bet, you should bet it all on one hand and then walk away if you win. The more you play, the more the negative edge eats you up.

Here are some guidelines I like to follow for systems with an edge:

1. Risk no more than 1.5% of your allocated capital per trade.  This means that if I invest 10% of my capital into a trade, I should pull the plug on a trade if it loses 15%.  Or if I invest 20% of my capital in a trade, I should pull the plug at a 7.5% loss.  Certainly, I still want to obey a stock's technical support or resistance, but ideally if you enter trades at good levels (near support on buys or near resistance on sells), you can manage your risk while potentially taking meaningful positions.

2. Use trailing stops. One of the ways I see traders kill their reward-to-risk ratio on trades is to take their profits too soon or let their former profits turn into losses.  If you have a fixed stop, once the position moves into a nicely profitable zone of more than 10% on a stock or more than 20% on an option, tighten your stop to your initial entry point.  This guarantees that your profit will not turn into a loss.  In addition, I like to use either a moving average to trail as a stop (for example, if a stock breaks under the 20-day average, that can be considered an exit signal on a 1-4 week bullish trade.  Another rule for options traders is to not let a profitable position give back more than half its gains on a closing basis.  So if you have an 80% profit, if it breaks to a 40% profit or less, go ahead and take the gains you have.

3. Have a re-entry plan.  Often a small percentage of our stocks make up the bulk of our profits.  Good trading involves pressing your winning bets, or coming back to your best ideas.  That's why I developed indicators like Acceleration Bands, which give re-entry points to get back on the big trends. This keeps your trading capital focused in the best opportunities, which is just as important as deciding how much to invest.

Price Headley is the founder and chief analyst of BigTrends.com.