This article is my homework elaboration for Beginner Level in Steemit Crypto Academy. Specifically, in the class of professor @reminiscence01 regarding Risk Management and Trade Criteria.
What do you understand by "Risk Management"? What is the importance of risk management in Crypto Trading?
To understand the term of Risk Management, we first need to understand the meaning of each word, namely Management and Risk.
Etymologically, management means the art of organizing and implementing. By implementing management, all forms of activities can be carried out effectively. Hence, the individual who manages or organizes the activities can achieve his goals.
In general, management is a process in which a person or group can manage something they are working on, for example, a project or a large business. The purpose of management is to make it easier for the people who own the project to achieve their targets effectively and efficiently. In other words, the person or community can maximize existing resources so that nothing is wasted and achieve optimal results.
Meanwhile, risk itself has various definitions. Generally, however, the risk is a possibility or something uncertain. Usually, the word of risk is considered something that is not good. For example, Mr. A carries out crypto token trading activities. At the same time, the crypto market has high volatility, so the price tends to change drastically every time. Since the price can drop at any time, Mr. A may suffer losses one day. This undetermined possibility and has a negative connotation is called risk.
Despite all these, we can manage or at least minimize the risk on a project by applying risk management. If we talk about a company doing business, the one who will analyze the company's business risks and find solutions to reduce the unpleasant impact is the people in the management team. The business company is different from trading.
As self-employed, traders have responsibility for the activities they carry out in the cryptocurrency market. It is an individual responsibility. All decisions depend on themselves, not on a specific official team. Therefore, traders need to comprehend and implement risk management to minimize the losses they will undergo. Even professional traders sometimes experience losses. With risk management, they can reduce this risk. Then, they can avoid bankruptcy or loss their trading account.
No matter how perfect the strategy is, traders must use risk management in part of their trading activities. If traders do not apply risk management, they will eventually fail to earn profitable income, sooner or later. Thus, all traders who want to stay longer in the trading world and get pleasurable profits must understand and utilize risk management in their trading actions.
THE IMPORTANCE OF RISK MANAGEMENT
Indeed, no trader has never experienced a loss. Regardless, the concern is how to avoid great losses that result in losing all our assets and even our trading account. This risk can be prevented as long as traders use Risk Management. It is important to note that traders must balance risk and profit for their trading career to be successful.
The reason traders like to take high risks is that they expect to make big profits. Nevertheless, that is not the right thing to do, especially in the volatile cryptocurrency market. Traders can lose their assets if they take too much risk. After all, if a trader loses all his money, he must prepare more capital to start trading activities. I reckon no one likes their money disappear just in the blink of an eye. Therefore, we must manage our money wisely. With Risk Management, traders can maintain the remaining capital they have. They can use the remaining capital as their next trading capital.
We can interpret risk management as our seat belt when driving. We never know what we will experience on the way. However, we can reduce the possibility that bad things will happen to us by using seat belts.
There are things called Risk Management tools that can help us manage and develop our assets. Some of the tools that we will discuss are:
- 1% Rule
- Risk-Reward Ratio
- Stop-Loss and Take-Profit
Overall, risk management aims to ensure that assets are used properly. Thus, traders can make proceeds and minimize losses. In fact, Risk Management is a crucial aspect of trading. Not only in trading but in any business. Subsequently, people who execute Risk Management can protect and develop their assets.
The research found some tips for traders to maximize their risk management:
Make a trading plan. Determine loss limits and profit expectations based on risk management tools to make the plan reliable. Follow the plan that has been made as a trading reference.
Limit losses and profits to a reasonable amount. We do not need to set a lot of earnings in one go. It is nothing wrong with a small profit. Just be consistent every day.
Manage our emotions. Do not expect too much. It is because every trader has the same risk. If we win, it is a pleasant moment, but do not need to be overconfident or overproud. Then, tend to trade again and ignore the existing risk management plan. If we lose, accept it calmly since we can do it again tomorrow.
Explain the following Risk Management tools and give an illustrative example of each of them.
a) 1% Rule.
b) Risk-reward ratio.
c) Stoploss and take profit.
A. 1% RULE
The first risk management tool we will discuss is the 1% Rule. It is a rule for traders not to take high risks, only between 1% to 3% of their capital. This 1% Rule can prevent losses that can be fatal, such as losing all assets or even losing a trading account.
To illustrate, Mr. A has $100 as capital. Today, Mr. A opens a position in the stock market two times and four times losses. At the same time, Mr. A applies the 1% Rule by taking a 2% risk. As a result, Mr. A will lose $16. Besides, he can trade again the next day with his remaining capital, $84.
I will put the calculation below:
Mr. A’s capital = $100, Risk = 2%
| $100 x 2% = $6
| $6 x 2 = $8
| $8 x 4 = $16
| $100 x $16 = $84
What if Mr. A is impatient and wants to take an 8% risk?
Mr. A’s capital = $100, Risk = 8%
| $100 x 8% = $8
| $8 x 2 = $16
| $16 x 4 = $64
| $100 x $64 = $36
All in all, with little risk, Mr. A can enter the stock market for more than two days if he has to suffer losses. Not with a high risk like 8%, he can only stay in the crypto market for not more than two days. Then, he will lose his entire capital. Thus, any trader needs to estimate the risk limit to the number he can afford.
B. RISK-REWARD RATIO
None of us can determine the exact profit or loss in trading. The only thing we can do is predict with good analytical quality. Even though we have analyzed and measured the market carefully and thoroughly, sometimes we can still experience losses. Nevertheless, we can manage our losses not to exceed the general target by using the risk-reward ratio.
Risk-Reward Ratio is a risk management tool. It is used as a standard to compare the loss risk limit and profit target whenever traders are in an open position.
There are several things that traders must prepare to start their activities. Some of them are capital and market analysis. Promising traders should consider the risks when opening positions. Did he succeed in his trading today? Or did he lose? If he loses, does it mean he loses all his capital? These questions he has to solve, and traders are fully responsible for all his decisions. Traders can use the Risk-Reward Ratio to determine their ability to accept the amount of risk that they will get.
As an illustration, Mr. A has a capital of $100. He must not lose all this money because it is the only money he has. Even though he had to lose, he could only sacrifice 3% of his capital. As a result, he can trade again with the remaining stock. Any trader can choose various ratios such as 1:1, 1:2, or 1:3. If Mr. A decides a 1:1, then both his limit of risk or profit is 3%. If Mr. A chooses a 1:2 proportion, then his risk limit is 3% while his earning is 6% (3% multiplied 2). Correspondingly, for the 1:3 ratio.
Risk-Reward Ratio can be an effective risk management tool, as long as the reward ratio that traders operate is higher than the risk ratio such as 1:2. Consequently, there is an opportunity to profit, although not much. However, traders can earn profits consistently. Overall, trading activity will be profitable because the chance to win is higher while managing the risk ratio he can bear.
All in all, traders do not need to worry or be afraid of facing losses since traders can operate the Risk-Reward Ratio in their trading plan. Traders are still able to seek profit again by utilizing the remaining capital. However, if a trader fails to anticipate their loss limit, he can lose all their capital. In consequence, he probably can get traumatized to do trading again. Not only can they control the loss limit, but traders can also generate consistent profits by using the Risk-Reward Ratio.
C. STOP LOSS AND TAKE PROFIT
To make a profit and minimize the risk of loss while trading, traders need to know when to stop loss and take profit. Stop-Loss and Take-Profit are simple methods that are used as risk management tools frequently.
A trader can prevent losing his assets and stop losses in the crypto market by making calculations beforehand. This calculation is nothing but the maximum loss he can take each time he enters the market if the price moves against his prediction. When the price direction against the expectation, the trader can stop his trading activity to prevent more losses. This action is called a stop-loss.
There are two ways to do a stop-loss, either manually or automatically. We can stop the loss manually by clicking the exit position in the buy or sell column at the left of the platform or clicking X at the order list. For automatic stop-loss, we can customize the nominal price for stop-loss in the buy or sell column.
Furthermore, a trader can also set his limit order to take profit. If his profit target is achieved, he will automatically exit the stock market.
By positioning stop-losses and take-profits, any trader can execute profits according to their target without taking a high risk in case the price moves in an unpredicted direction. It is highlighted that the 1:2 ratio is recommended to set the stop-loss and take profit. Following this, traders ought to use a trading strategy to analyze the market direction such as trendlines, market structure, or indicators.
In trading, all decisions must be calculated and analyzed systematically. Following this, we can earn returns. Thus, we cannot lose our money due to emotion and neglect the reliable analysis.
Open a demo account with $100 and place two demo trades on the following;(Original Screenshots on Crypto pair required).
a) Trend Reversal using Market Structure.
b) Trend Continuation using Market Structure.
TREND REVERSAL USING MARKET STRUCTURE
1. Entry Criteria
I make sure that the price doesn't create a new lowest low. That way, I can draw trendline resistance on the market chart to make it easier for me to analyze the price action.
Then, I retest the market structure by ensuring it is a sign of a trend reversal, a bullish trend.
Hence, I waited for the candlesticks to form entirely. Also, it does not cross the resistance trendline. If the candlestick is still above the trendline resistance, the trend reversal is confirmed.
The candlestick that appears after the retest is the entry point to buy trade in this market.
2. Exit Criteria
For stop-loss, I must set it to the price at the resistance trendline which already turned to support trendline. As I entered the SOL/BTC crypto market today, the exit point for stop-loss should be at the price of approximately 0.0033500. (I drew it exit the support trendline)
As the best ratio for risk-reward is 1:2, the take profit should be twice my stop-loss. However, the nearest resistance in this market is at 0.0036650. I can take it at the first target. Then, I will use the 1:2 RR for the next target which is at around 0.0038500.
1 Entry Criteria
I make sure that the price doesn't create a new high.
Within this trend, the broken market structure occurred several times. The first breakout failed to create a bearish trend because the price goes up again and crosses the trendline. However, the price went down again and the market was really in a bearish trend.
After that, I did a retest by ensuring the price does not break the trendline again. Then, the trendline will become a resistance level.
When the second candlestick is formed, it is the entry point for this market.
2. Exit Criteria
In the same crypto market, SOL/BTC, I set my stop loss at 0.0039189.
For the take profit, I placed 0.0036907 as my first target. That is the limit order for my reward as I use the 1:2 RR.
TREND CONTINUATION USING MARKET STRUCTURE
1. Entry Criteria
I identify a bullish trending market by looking at the Higher High and Higher Low. If the trend creates a new Higher High and a new Higher Low, the trending market is in an uptrend.
I confirm again by retesting the market structure and the candlestick is created perfectly above the trendline.
When the next candlestick designs, that is the entry point for this market.
2. Exit Criteria
- I set my stop loss at 0.0017547 in the SOL/BTC crypto market.
- As I use 1:2 RR, the reward ratio must be twice the risk ratio. Hence, I set it to 0.0023737.
1. Entry Criteria
I identify a bearish trending market by looking at the Lower High and Lower Low. If the trend creates a new Lower High and a new Lower Low, the trending market is in a downtrend.
I confirm again by retesting the market structure and the candlestick is created below the trendline.
If the next candlestick designs, it is the entry point.
2. Exit Criteria
- Still, in the SOL/BTC crypto market, I positioned 0.0039189 as my stop-loss limit. Also, the price is above the price during the entry point.
- Last for my take profit, I manage it at the price of 0.0034621 after it forms a new Lowest High.
Trading is not only about profits. In fact, this activity does risky. Any trader can claim to have a superb strategy and market analysis. Yet, it is useless if he does not have good risk management. All traders, whether they are professional or newbies, will experience losses. The implementation of risk management in a trading plan can be helpful for traders to set a loss limit. So, they do not go bankrupt. Hence, they can continue trading activities with consistent profits.
Thank you to all professors who enlighten all the students in Steemit Crypto Academy through their guidance and knowledge. Your support always helps us present and future.