Risk & Trade Management – The Birb Nest
When it comes to trading, the goal is always to make a profit. However, the road to success is not always smooth, and the journey is often filled with risks. That’s where risk management comes in.
Trade management, on the other hand, involves the application of strategies to optimize the potential profits of a trading strategy. It includes the use of tools such as stop-loss orders, profit targets, and position sizing to maximize returns and minimize losses.
In this blog post, we will explore the importance of risk and trade management in trading and discuss some best practices for implementing effective strategies.
Risk Tolerance
💡 When entering a trade, it’s important to consider your risk tolerance. Personally, I approach each trade with the mindset that I’ve already lost the money I’ve invested. This helps me understand that successful trades aren’t solely focused on potential profits, but also on how much they could potentially lose.
As a general rule of thumb, if you’re risking USD 1.00, you should aim to make at least USD 2.00.
In my experience, I prioritize achieving a higher risk-to-reward ratio (R:R) while also being realistic. Pursuing a higher R:R requires patience as you wait for the price to reach your take profit level. However, it’s important to remember that there is no guarantee that the price will reach that level. Therefore, it’s essential to detach yourself from the outcome of the trade and be prepared to close it if things don’t go in your favor. I understand that this can be a difficult task.
Measuring Risk
These are the two main ways of measuring risk:
Here’s an example of how using a 1% risk per trade in a 20 trades sample, can benefit the longevity of your account instead of taking on excessive risk:
Risk to Reward
The traditional approach of using risk-to-reward as your main trade and risk management tool is highly effective. This tool measures the amount of risk you are taking on in comparison to your potential reward. By using this tool, you can ensure longevity in your trading account.
To illustrate the effectiveness of risk-to-reward, let’s examine an example of an equity curve with simulations of different risk-to-reward ratios and strike rate percentages.
Win rate: 50% – RR: 1 to 1
In this scenario, a 50% win rate with a 1:1 risk-to-reward ratio will prolong the longevity of your account. However, this strategy is essentially gambling, as the results of a 100-trade sample data set show that the chances of a positive or negative balance are almost 50/50. It’s like flipping a coin.
Win rate: 50% – RR: 1:2
This is a great example of a high risk-to-reward ratio. Despite a 50% win rate, you can still expect to win 5 trades out of 10 on average. What’s more, your wins will outweigh your losses two-fold, making it much more likely that you will be profitable after a sample of 100 trades.
Please keep in mind that these examples are intended to provide guidance, and it is important to consider the time required to execute 100 trades. The time needed will depend on your individual trading style. For example, if you are day trading and only taking one trade per day, it will take 100 consecutive days of trading to have a statistically significant sample size.
Inter Market Correlations
This is an important consideration: Most markets are correlated with each other, and the main difference between them is risk-on and risk-off assets. When you only trade cryptocurrencies, you are essentially trading nearly 90% correlated risk-on assets, which magnifies your risk.
If you take a long position on ETH, LINK, and XRP at the same time and BTC experiences a significant drop, even though your analysis is sound, these altcoins will follow BTC and you will end up getting stopped out on all of them. Essentially, you are risking 3% of your account in a single correlated market.
To achieve success in trading, it is crucial to efficiently manage your trades and risks. This includes having a clear understanding of your risk tolerance, utilizing dependable risk-to-reward strategies, and measuring risk accurately. By doing so, you can minimize losses and maximize gains. It’s important to remember that trading is not a get-rich-quick scheme, and patience and discipline are necessary for long-term success.
🐦 At The Birb Nest, we have a dedicated team of Trading Analysts who are available 24/7 to help you reach your trading goals and learn about risk & trade management. We’ve already shared several educational materials inside our discord that you don’t want to miss with more in-depth analysis of these topics.