Financial markets and risks are like ice and fire, they are so intertwined that we, unfortunately, cannot get rid of the risks entirely. But it is up to you to organize life with a minimum amount of problems. If you define risk management as the main point of your trading plan - and you will always control the risks no matter of how you trade and what type of currency you trade.
The main task of ideal risk management is to keep the maximum amount of your money in unprofitable deals to further use them in profitable ones.
You are threatened by various risks.
Any financial transactions are accompanied by risks, and their name is legion. They can be classified as:
- the market risk when the value of the asset will change adversely;
- the risk of scam when the operation of a particular coin does not fulfill its promise or did not plan to fulfill them at all;
- liquidity risk that it would be impossible to transfer the entire volume of a position to fiat money or its equivalents at the best prices;
- the operational risk when suddenly it will be impossible to perform trading operations or the input-output of assets.
In this article, we will find out what is market risks: you will learn which risk management analytics should be included in your trading plan and how to determine the acceptable amount of risk.
Let's say that “risk” means the possibility of losing money or trading capital all in all. In this case, a thorough risk assessment implies an understanding of two key things. The first is how much you can lose in a single trade, and Stop Loss can control it. The second is how much you can merge for all the time, and this value is also called the “worst scenario” for the trading period.
These are specific values, and you need to add them to your trading plan.
Risk management is a strategy. It includes:
- Position volume
- Funds Management
- Stop Loss Tactics
Let’s consider in more details:
Position volume: calculation and risk control according to the “2% and 6% rule”
When we talk about the volume of a position, we want to say a percentage of funds you risk in each deal.
Why is this a key point
When you trade $ 10,000 coin ... how much should you to buy or sell: 2%, 10%? If you do not have an answer to this question, you will definitely have problems. You have to fix it in the trading plan.
Count all as a percentage could be taken s a rule
The risk is the likelihood of an adverse outcome, on the other hand, it is a level of possible financial loss. The risk is a two-dimensional value characterizing the probability and volume of losses from total capital. All these values are measured in percent.
Consider exchanges commissions in your calculations:
- transfer of funds, deposit, and withdrawal;
- opening a position (and closing with another position);
- for the use of margin leverage (percentage of landing or swaps), etc.
More risk - more profit
If everything you do is right, the increased risk should bring high profits and vice versa. If we take excessive risks to earn as much or even less, then such an investment should be abandoned.
This is the creation of a balanced investment portfolio.
However, diversification should not begin with a portfolio, but with reduced operational risks. Some trading platforms have the reputation of hacker attacks and threats of closure. In case of occurrence of these risks, the possible losses can be reduced simply through the early distribution of funds among several exchanges.
It is important to build your risk management strategy according to your goals: how much money do you plan to earn and how much time can you spend on it. A strategy can be corrected, and the losses may be much more than you expected, but without a goal and a plan, you cannot analyze the effectiveness of your actions.
Position Volume: Risk Management
Step # 1: correct calculation of a new position,
Step # 2: Funds Management in General
The typical mistake of many newbies is to risk 100% of the capital on a single trade/position.
Do not put all the eggs in one basket - this saying perfectly describes a similar situation.
How to determine the maximum allowable risk for each operation: limit the risk per session with the “2% and 6% rule”
There are a lot of risk management recommendations. One of them was described in his works by Alexander Elder. It should be applied at the initial stage until its own system of risk determination is formed.
"Sharks" in trade and the rule of 2%
The volume of the transaction and may be less: 30%, 50% or more capital. “The risk of being eaten by a shark” - as Elder called a similar situation: a few large losses can reset capital, and this is the essence of the error.
There is a simple defense against it: the size of one position must be less than or equal to 2% of the available funds. This is the very “two percent rule”.
“Piranhas” in trade and the rule of 6%
Sometimes a trader cannot stop a series of losing trades - Elder compared them with a flock of predatory piranhas, who grab loot in pieces. It is often difficult for a trader to stop for psychological reasons. The danger is that with a large number of such transactions, capital will fall into the high-risk zone.
The 6% rule limits the share of funds used in the trading and thus sets the maximum permissible risk per session. With a loss of more than 6% of the capital, it is necessary for some time to stop trading (Helder recommends 1-2 weeks). Firstly, to analyze the situation, secondly, to avoid psychological errors.
Thus, Elder recommends that we should not open more than three transactions at the same time, limiting each one to two percent.
Of course, these rules can be modified over time to suit your trading strategy, change the percentage and time spent on the analysis, however, the general concept is recommended to remain in its original form.
- Build your risk management strategy according to your goals.
- Each trader should determine his own size of risk. It can be determined by personal factors such as age, social status, etc.; the nature and level of psychological tolerance for risk.
- Risk management can be aggressive, conservative or something average, and can be changed depending on the market situation.
- For beginners, it is important to learn 3 basics of risk management: control of the position volume, money management and tactics of using Stop Loss.
- Three rules to control the volume of a position: open no more than three transactions at a time, a rule of 2% about Sharks and a position size and a rule of 6% about Pirani and the maximum amount of losses.
We hope this article will help you reduce losses and increase profit, and our algorithms will implement your strategy around the clock. If you start earlier - you will see the result earlier!