What it is, and how to employ it with confidence
Risk management at times can be a daunting aspect of trading, especially to beginners, and even more so to beginners in a time of market indecision. The definition of risk management is the process of identification, analysis and acceptance or mitigation of uncertainty in investment decisions. Essentially you want to quantify the potential for losses in an investment, and adjust for risk tolerance in that investment.
Surprisingly, one of the most overlooked aspects of risk management is also one of the simplest. Having a plan. A common phrase has been around for many years on trading floors and communities around the globe that states, “Plan the trade and trade the plan”. This is highly simple to the point that it is all too often overlooked. One aspect of having a trading plan is studying the chart of the commodity, security, stock, or future you are trading, and planning an entry as well as an exit based on the information the chart can tell you. In a lot of cases you do not have to be a professional in market analysis, Elliott Wave theory or otherwise to make these decisions. Some traders and investors prefer to use brokers, and even in the digital asset market this is becoming more popular as these securities and “tokens” emerge into the mainstream. This can also be achieved by simply reading the candlesticks on the chart or using a couple moving averages and other indicators together in combination to get a better idea of where the market is, and may be headed. I will discuss different chart indicators in detail in a future issue.
The very first part of planning your trade is knowing what price you are willing to buy and sell. It sounds simple enough, and it is, but when trading a volatile market, it becomes more than that. This is where I come to a term that you probably have heard being thrown around a lot, the Stop-Loss. The Stop-Loss and Take-Profit orders are not a part of every digital asset exchange, but I highly suggest you do not trade without it. Of course, the first rule of investing is that you are never supposed to trade with more than you are willing to lose, but these order types will ensure you minimize risk when entering a trade, as well as lock in profits when the market moves in your favor. The stop-loss function is a feature readily available on most exchanges and serves as a way to cut your losses when the market moves against you. This is usually a predetermined price set by the trader. Conversely, the take-profit order is not as widely available on newer digital asset exchanges, and serves to lock in profits during a winning trade. These order types trigger a sell or buy order when the price is reached, terminating the trade automatically. This feature is helpful for swing traders and investors alike and everyone in between that cannot commit the time to watching the chart of the asset being traded day in and day out.
I get asked a lot of questions about the stop-loss function and it’s usually, “Where do I place my stop if I entered at “X” price?”. Unfortunately, there is no one right answer for this, nor is there a “one-size-fits-all” equation. Some people will swear by using one set percentage, say 10%, others will say 5% below or above (depending on if the trade is long or short) the next support line. It can start to get very technical considering these factors but at the end of the day, when you have calculated your risk to reward ratio for the trade, you have to determine the stop-loss level for yourself based on a few factors. These can include your personal level of accepted risk, and how volatile the market is at that time. In a highly volatile market such as digital assets, you are asking to get “John-Wicked” if you set the stop-loss to tight, but if it is set it too loose and it does not trigger even though the market did take a turn for the worst, you end up getting stuck in a trade for a long period of time or worse yet, having to cut your losses to exit the trade anyway.
This article is geared to newer traders in any market, not just digital assets, and in conclusion I would like to sum some things up. When beginning to trade you have to decide first what your goals are. If you throw all your money into a strategy you only tried using for a few months, you will lose all your money and end up right where you started. But if you take the time to learn, invest in the knowledge required to succeed, and take a solid six months to a year to determine first what kind of trader you are, you will have a much higher success rate. Do not start trading with a lot of capital, you will lose it and here is why. You will win a few trades and eventually enter into a huge a position that goes bad, and lose it. This is when panic sets in and you start getting emotions tied in with trading. Instead of doing this, slowly build up a portfolio by adding 5 to 10 percent each month so that when you do realize some loss it is not surprisingly terrible to your wallet. Do not quit your job, do not trade with more than you can comfortably afford to lose, plan your trades and set stop-losses and take-profit levels for every position you enter. If you follow these basic rules you will be well on your way to having employed very good risk-management skills for your trading style, and can become very good over time as you learn.