There are a few things each trader should master before heading into markets. Risk management is at the top of that list in my opinion, because without capital preservation, what are we doing? Gambling our future?
Risk management plays an important role in any market and is a key element of success. Many traders believe that mastering risk management strategies is not important until you trade with bigger positions, however, THIS IS FAR FROM TRUTH. If you want to get maximum gains, you will need to manage your risks and minimize your losses.
You will lose trades, you will make bad decisions, remember that! Professional traders with great trade records make bad decisions. Closing a trade with big profits can cloud your judgment and you become overconfident in the next trade. You shouldn’t be ashamed of it, it’s part of the game. In this short article, I will describe a few different strategies of risk management, what to avoid and how to master them.
We will look into:
- Position sizing
- Stop Loss and Take Profit
- Risk/Reward ratio
Risk management strategies
Everyone has heard of the saying “Do not risk more than you can afford to lose”. Usually, it is not advised that you enter with more than 10% of your portfolio in one trade. You can trade a bigger position but you should keep a tighter stop loss then. Dont worry, i will explain everything, lets jump into position sizing now.
- Position sizing
Position sizing means how big should your position should be (How many coins a trader is willing to buy). Inexperienced traders are dreaming of big profits and they enter with 50% or 100% of their trading capital. You need to keep in mind that this will expose you to a big financial risk. There is a very simple yet efficient way on how to calculate your position size.
First of all, you need to decide how much % of your portfolio are you willing to risk on a trade. This number represents the amount of money you are willing to lose if the trade goes in the opposite direction. In my opinion 2–3% for swing trade is good enough.
Risk (amount of capital you lose if you get stopped) = Your position x StopLoss %
Example: If you have $10,000 on your account, and you are ready to risk 2%, then your risk is $200.
Okay, now you know your risk, but how to calculate your position size with this info? After you know your risk, all you need is the entry price and stop loss. Let’s look at a formula and an example.
Position size = Risk in USD / (Entry price- StopLoss)
Example: Let’s say you want to LONG Bitcoin at $50,000 and you decide that your stop loss should be at $49,000. Considering that you are willing to risk $200 on this trade, the formula would go like this:
Position size = $200 / ($50,000 — $49,000) = 0,2
The result is 0,2, which tells you that your position should be 0,2 bitcoin. If you enter a trade with 0,2 bitcoin and your trade gets stopped at $49,000, you will lose $200. Keep in mind that this formula can be used on all assets.
2. StopLoss and Take Profit
I am pretty positive that everyone has heard of Stop Loss and Take Profit feature before. Real question is, do you use them? Stop Loss closes your position when a price decreases to a certain price level, so you don’t have to worry about sudden dumps. Take Profit, on the other hand, liquidates your order when the price rises to a certain price level.
Stop losses will prevent your trades to dump to levels you don’t want them to, whereas Take Profit will help you secure profits before the market goes into reversal.
3. Risk/Reward Ratio
The Risk/Reward or RR ratio shows you the actual level of risk in the trade and compares it with the potential returns. You probably heard of the saying: The bigger the risk, the bigger the gains. This strategy will allow you to know when it’s profitable to enter in a trade and when it’s not.
The risk/reward formula is:
R = (Your target price — Entry price) / ( Entry price — StopLoss)
Lets take the data from the position size example.
- StopLoss : $49,000
- Entry Price: $50,000
- Your Target Price: $52,000
So our ratio on this trade would be:
R = (52,000- 50,000) / (50,000–49,000) = 2
The result tells us that on this trade our risk/reward ratio is 1:2. This means that you will win twice as much if the trade goes in your way, then you would lose if it goes in the opposite direction. I wouldn’t advise trading with a risk/reward ratio lower than 1:1.
Mastering these three techniques will allow you to manage your risks and minimize your losses. Try these techniques with smaller trades and after you master them, you can scale the trades. It’s hard to identify what will happen on the markets, that’s why you should be careful and manage your trades properly.
You can change your life by trading cryptocurrencies, do not lose everything because of greed. Professional traders are not successful because they won a few lucky trades, they are professionals because they managed not to lose everything they have when the market reversed.