This is not Financial advice nor am I a Financial Advisor, this content is for educational purposes only.
Yes yes you have heard this all before and everyone and their mother speaks about it constantly, RISK MANAGEMENT!!!!
As a new trader most trades you put on are emotional decisions you make without considering anything. You have probably read up about an indicator or a strategy and taken a look at a chart and immediately tried to make assumptions about which direction you think the market will move. You draw your fancy lines and add the indicators to the chart, check the candlestick patterns, then log into your favourite trading platform and put on a trade.
The problem with the above is that technical analysis means nothing unless you are aware of the risk you are willing to take on each trade.
Risk Management or Protecting your capital is the most overlooked subject in trading. I will be going through a few ways you can develop your own Risk System.
Limiting risk, can be achieved in a number of ways they include:-
- Setting stop losses and take profits,
- Calculating Expected Return
- Using position size
Managing your Risk cuts down your draw downs and helps protect your capital in order to stay longer in the market.
The development of a Risk Management Strategy should be on your list of priorities when you start learning to trade. Below are a few ways that you can start incorporating Risk Management into your strategy.
Your approach to Risk should be objective and strategic, this means that once your rules are set, emotion should not allow you to deviate from these rules. Starting a journal will now become necessary, going over your trades each week are the key to developing this strategy and fine tuning it until you find an edge.
- Setting Stop losses and Take Profits
Essentially setting up Stops is the difference between gambling and trading, however your Setups will determine your Entry, Stop Loss and Take Profit, a basic understanding of Price Action is necessary in order to determine these on each Setup. You can take a look at my Video Series on Price Acton.
Stop Losses are Price points where traders decide to get out of a trade. Not having this set before entering the trade allows to much emotion creep in. I am sure you have entered a trade where price has gone against you and the loss just gets bigger and bigger and you keep thinking it will come back.
Having a clear plan before putting on the trade will restrict this from happening.
“But every time I put in a Stop, the price triggers my stop and the market immediately reverses” This is where having a journal will help you if you see that this happens on the same setup over and over again, adjust your Stop a little to allow for this, you may even find that your setup needs a little adjustment.
Your Technical analysis should at a minimum mark out Support and resistance. These areas are where you should look at placing stops and adjusting as you start developing your strategy.
Take Profits are price levels Traders are willing to get out of a profitable trade, these are often staggered as price moves in the direction they anticipated. Journaling here is also very important because you will find that you might be cutting the trade off too early or too late too often and a slight adjustment will bring better results.
I use market structure as a guide as well as Pivot points and VPVR to get my optimal stops losses and take profits, other traders use percentages or points away from their entry.
2. Calculating Expected Return
Without knowing your Stop Loss or Take Profit you will not be able to take calculate your return, you can manually do this by using the following formula
[(Probability of Gain) x (Take Profit % Gain)] + [(Probability of Loss) x (Stop-Loss % Loss)]
You could also use the tool in Tradingview which is obviously the quicker option. The tool you use is in the drawing pane on TV
Below is an image on how to calculate the your expected return in the following example i will use a Long Position to demonstrate.
My Strategy is to buy a retest to an important level (SR Flip) the stop loss is at the next level of Support and the take profit is the First Pivot extension on that Time Frame
The Expected Risk reward Ratio is 4,19, that means for every dollar you willing to risk your expected return will be 4.19, Risk Reward is not to be used in isolation, you will need your strike rate as well for the number to make sense because you do not win 100% of your trades.
The Risk Reward tool also helps you with position sizing by double clicking on the beautiful range you just drew you can insert your account size and the tool will work out your balance at either end of the trade this will also show you your position size
If you risk 2% of your account in this case $2000 you will have an ending balance of 98 162 if you are stopped out or 108 222.7 if the target is reached.
3. Position Sizing
The size of your position is very important when trading, your risk tolerance depends on your preferences in this regard. The general rule is 2% for retail traders, i personally use 3% when trading Bitcoin.
Pretty straight forward to calculate this
if you have a 10k account 2% is $200 per trade maximum
Leverage does NOT change the Position Size calculation.
DUEDEX NEW RISK MANAGER TOOL
I just opened a new Duedex account and received a $10 sign up bonus to test out the tool.
Finally an exchange has created a very handy tool to do all the above calculations for you before you put a trade on.
In the top right hand corner you will see a new tab called Risk Manager
Once you click into it you will be able to set up your trade each time according to your Risk strategy
You can input all the info as required using Price or a percentage
Then put in your Risk tolerance in my case 3%.
The tool then calculates how many contracts I can open in this case I can open 77 contracts with a RR of 0.33
I risk loosing 2.27 USD and gaining 6.93 USD
You can also manually put in the amount of contracts you want to buy/sell and the calculator works out the Risk and Reward for you
Duedex is continually striving to put out a better product, stay tuned for more updates.
Sign up here for an account and receive $10 to test out the Risk Manager tool please comment below on other innovations you would like to see from Duedex
For more info Check the Support Doc from Duedex here
