Risk Management and Money Management: Organizing Your Finances

One of the biggest challenges in trading is the temptation to recover losses after a bad trade and prove to yourself and the world that it was just a fluke. This mix of excitement and adrenaline can cloud your judgment, leading to emotional decisions that always negatively impact your finances. Effective risk management helps traders avoid such impulsive actions.

It’s important to understand that losing trades is normal and an integral part of trading. The market’s volatility can work both for and against you. To avoid the agony of every losing trade, it’s crucial to grasp the basics of risk management and money management, recognizing that every outcome is a valuable learning experience and a step towards enhancing your trading skills.

Risk management and money management are essential for every trader. Ideally, no trade should be executed without considering these two factors.

Risk Management

Risk management involves making decisions aimed at reducing the likelihood of financial losses. It determines how much of your capital to invest in a trade and what percentage of your deposit is acceptable to lose without it being critical. Thus, risk management controls the balance between loss and profit.

Here are four golden rules of risk management for any trade:

1. Never, under any circumstances, invest your entire deposit in a single trade.
2. Divide your deposit into parts and invest no more than 20% (one-fifth) of it in a single trade.
3. Determine the amount of your deposit you can afford to risk without significant distress. Ideally, this should be 1–3% of your deposit.
4. Calculate the risk/reward ratio, which is the potential profit compared to the potential loss.

In simple terms, the desired (expected) profit should generally exceed your potential loss if a stop-loss order is triggered. The optimal ratio is 1:2 or 1:3. What does this do for you?

Even if some trades are losing ones, the profits from the winning trades will cover the losses.

This is the recipe for surviving in the market.

Example Calculation

A trader buys an asset at $50, sets a stop-loss at $40, and places a take-profit order at $75. The risk in this trade is $10 ($50 — $40), while the potential profit is $25 ($75 — $50).

Thus, the risk/reward ratio is: $10 / $25 = 0.4.

Here’s the breakdown:

• If the ratio is greater than 1, the risk is higher than the potential profit.
• If the ratio is less than 1, the potential profit exceeds the risk.

For simpler calculations, you can use Binance’s built-in calculator.

Money Management

Money management is the smart handling of finances, or the science of allocating funds to make trading comfortable, minimize risks, preserve assets, and grow them.

While it might seem straightforward, many traders make impulsive trades and abandon rational thinking when faced with fear and greed. The main challenge in trading is managing emotions, not finding the right entry point. Money management, alongside risk management, helps in this regard.

Money management involves following one crucial rule:

Divide your deposit into two parts:

1. Trading deposit
2. Investment deposit

Stick to a strategy of accumulation and risk diversification:

• Allocate a portion of the profit from each successful trade into long-term assets like BTC or ETH, or your well-researched favorites.
• Convert part of the profit into stable currencies or invest in other markets.
• Regularly rebalance your investment portfolio.

Below are some tips to help you manage finances wisely and build an emotionally stable system:

• Stick to your system and strategy. Learn from others but apply their experiences wisely.
• Don’t trade every day. Give yourself time to rest, reset, and review mistakes.
• Diversify your investments. Don’t put all your funds into one asset or with one broker.
• Avoid chasing too many trades at once. You won’t be able to monitor them all and risk losing your money.
• Keep a trading journal to track the number and results of your trades.
• Take profits and reward yourself and your loved ones.
• Close positions if you’re unsure about future growth.
• Stay updated with market news.
• Minimize losses and risks.
• Don’t check quotes every 5 minutes. Shift your focus to reduce emotionally-driven decisions.

Conclusion

We’ve all made emotional decisions we later regretted — impulse buys, spontaneous investments without enough information, and more. These actions create significant holes in your finances and strain your relationship with money. Emotions are great for personal relationships but not for financial decisions.

To sleep soundly, traders need to understand that acceptable losses are normal. Mastering the basics of risk and money management will simplify managing your deposit, making it smart and rational. By following the tips above, you’ll find balance and keep your deposit under control. If you want more tips and secrets on risk and money management, join us at Cosmic FOMO.

Wishing you less risk and more profit!