You must already know that the financial markets are full of risks.
But still, some people do make good earnings in trades. So the question is: How?
The answer: They pay attention to risk management just like they pay attention to where to invest, sometimes – A LOT MORE!
So, how to avoid risk?
Remember: You can NOT!!! There is no guaranteed earnings in cryptocurrencies, forex, stocks, bonds, options nor anywhere else! If someone was earning before you it is not a guarantee that you will earn too!
But you can be smart and smarter.
When someone suggests you invest in a particular asset, here’s what to pay attention to:
– If you are guaranteed a profit, it’s definitely a scam.
If it is not guaranteed by the company, but the individual who represents that investment, then that individual is either a fraudster or uninformed. In that case, I suggest you find someone else.
– If the currency\asset can not be bought or sold on the free market, you should be very cautious. In this case, you should assume that they can manipulate the price and keep it at an unrealistically high level in order to make the investment cost-effective.
– Cryptocurrencies are generally open-source if not, it is doubtful. When a currency is hidden by code, it is most often because they want to hide the fact that they are not actually cryptos.
WHERE THE TRUE RISK IS?
First of all, you have to know that long-term trading inevitably involves losses and no trader can have 100% winning trades all the time.
And the answer: IN YOUR KNOWLEDGE!!! And your attitude too!
To succeed as a trader, the size of your potential losses needs to make sense compared to the original profit potential on each new position. If you are not disciplined and your attitude to risk and reward is not balanced, it is easy to fall into the trap of holding losing positions for too long. Having a hope that things will turn around before eventually closing out for a large loss, makes little sense if your objective was to make a small profit over a few hours.
The long-term trading profit comes from this combination:
– the number of profitable trades compared with the number of losing trades
– the average value of profits on each trade compared with the average value of losses.
The most important is to combine the relationship between reward and risk.
Many successful traders actually have more losing than winning trades, but they make money because the average size of each loss is much smaller than their average profit. Some have a moderately average profit value compared to losses but a relatively high percentage of winning positions
RISK MANAGEMENT IS IMPORTANT
Managing risk means that you have identified the dangers and have taken the trades that have a high probability of success.
If you don’t have a consistent risk management strategy, you will lose money. It’s as simple as that!
You should ask yourself:
1. What position size per trade should I take?
2. How much of my funds should I risk?
You can use two great techniques, taken from the world of game theory, which is used by professional traders.
a) RISK OF RUIN (ROR)
Use the Risk of Ruin formula: (1-(W-L))/(1+(W-L))^U W/L = win/loss percentage U = Capital units
Let me explain to you this on 2 examples (both have 30% drawdown). We have two traders.
Trader A: $50k pot, 10% risked per trade, 60%/40% win/ loss ratio, 3 capital units: = 30% RoR
Trader B: $50k pot, 1% risk per trade, 60%/40% win / loss ratio, 30 capital units: = 0.000005214% RoR
It’s obvious what you have to do! Increase your W/L ratio or reduce your trade size. You donít want to lose 100%, so you have to set yourself a maximum limit of 30% of your portfolio value.
b) KELLY’S CRITERION:
This is a money management technique that was developed by John Kelly, a physicist and computer scientist, who worked for AT&T in the 1950s.
This theory can give you answer to questions: How many trades should I have on at once and How much of my portfolio do I want to put at risk, per trade?
That means that you must have a strategy.
Example: 60%/40% Win / Loss ratio average risk-return = 2 : 1 = 33.3%This shows that you could use 33.3% of your capital on a particular strategy.
You should have rules that you will act upon while you are in a live trade or investment. These rules should include how you will move a stop or adjust to a trailing stop.
You should always be taught to trade with Stops. Stops are a trade management tool that let you stop a loss or stop a profit (they are known as a LIMIT order, too). The golden rule when using stops is, don’t ever adjust your stop, pushing it wider, just because the trade is going wrong this is fatal!
By using orders such as the limit stop order, the market stop order, or the trailing stop order, you can easily control at what point you exit a position.
In this way you can limit the risk you are exposed to on each and every trade you make.
Position sizing is basically deciding how much of your capital you want to use to enter any particular position, it is a form of diversification.
If you use a small percentage of your capital in any one trade, you will never be too reliant on one specific outcome. Even the most successful traders will make trades that turn out badly from time to time. The key is to ensure that the bad ones don’t affect you too badly. And avoid money risk.
INSTEAD OF CONCLUSION
It is important to have a detailed trading plan that lays out guidelines and parameters for your trading activities.
Risk and trade management may not be the most exciting part of trading, but they are absolutely essential if you don’t want to lose all your money.
And the best advice you will ever get: Trading and use of information presented here are at your own risk. And your money risk, also.
Feel free to share this with someone you know to be interested in trading.
Are you a beginner?
Click here to see what we’ve got for you on the How to Start Trading – Beginners
Are you an advanced trader?
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