“How do you manage your risks?” - is a question that puzzles 9 out of 10 traders. Not so important is market analysis, not so important is strategy and tactics, and not so important is what is happening in the market. But the most important things are financial protection and risk management. The market is a fairly chaotic environment. It is chaotic because each of its participants does not know the motives of the others and the trading psychology that drive them to buy or sell. Therefore, even with a good trading strategy, you can end up with a series of losing trades.

It is impossible to be right on every trade. There will always be losses and you should be prepared for this. Risk management and accepting potential losses are the solid foundation on which a trader’s development begins. In this article, we deal with the basics of risk management and give practical advice on how to manage risks.

The basic rules of money management

In trading, risk management boils down to simple rules:

1. Develop a plan to limit losses in the event of an unfavorable outcome by placing stop orders (market stop losses, stop limit orders to reduce positions).
2. Control the overall risk of open positions, monitor risks, and follow your mitigation strategies.
3. The potential risk should be many times smaller than the potential profit.
   For example:

4. Diversification, which we talked about in the article "How to diversify a trader’s portfolio?.

A trader is not a positioning investor. A trader cannot wait for years for an asset to rise. He identifies when it is more likely to go up and takes his take profit.

What to do if an asset falls after buying? Some will say to wait, it will go up again. But a professional trader knows that it is better to make up for the loss and come up with another trade idea where you can potentially make more money and the probability of an upward movement is higher. After all, an asset can fall for a very long time and very hard.

There are traders who bought BTC at 19,000 USD in December 2017. During 2018, BTC fell to 3,500 USD. What do you think: if they had been told in 2017 that BTC would be at 3,500 in a year, what do you think they would have done? Most likely even the riskiest would have sold out and limited a small loss on their finances.

In our online university we deal with more risk management cases and offer interactive risk assessment exercises for entering a trade.

Stop loss as an important part of loss limitation

Stop loss orders are an acceptance of risk. Unfortunately, many people ignore stops. This is usually backed up by the following arguments:

• My stop will be knockout anyway and the price will move without me!
• I only trade on the spot, there is no liquidation, so why would I need a stop?
• I use cross margin, which covers potential losses in trading.

Let’s look at each of these points in more detail:

*** My stop will still be knockout and the price will go without me ***

Yes, it is quite possible. But if it happens within the framework of your trading plan with clear rules, is it possible to say that you have done something wrong? The only thing we can advise you to do is to limit the risks of your trades so that even a few losing trades do not cause you too much emotion.

*** I only trade on the spot, there is no liquidation, why would I need a stop? ***

You’d think it would be a big deal if the spot price went down instead of up as expected. You could just become an investor and wait it out, a month, six months, or a couple of years. But you are essentially throwing yourself into the unknown. Your investment will be frozen and eventually, it will end up in one of the scenarios:

1. You will have to accept the loss and close the deal having lost a significant portion of your invested funds.
2. Continue to watch the price slide into the abyss, which in turn will erode your emotional resilience.
3. Your asset will be delisted from the major exchanges and you will lose all your investment.

Of course, one cannot rule out the possibility that the asset could eventually recover the entire drawdown and even grow nicely thereafter. But do such trading risks outweigh the growth of losses on other assets that never grew?

***I use a cross-margin to cover potential losses. ***

And are you sure that there won’t be a severe squeeze due to a technical error or low liquidity that wipes out your investment? I think those who have been in the market for more than a year have seen such squeezes many times before. Just think, just one trade, just one stop not placed can TOTALLY wipe out your deposit. The chance of this happening is of course not high, but it is there. Is it worth the risk?

Adequate risk

We have accepted that losses are inevitable in trading and recognized the importance of the mandatory use of stops. Now it is time to focus on the amount of risk that needs to be built into each new trade.

In my trading, I (noted – author of the article) follow the following rules in terms of risk assessment:

• The risk per trade will not exceed 1%.
• If there are not enough arguments for an entry, a trade is opened with half the risk or not opened at all.
• If a new approach is being tested, the risk must be even less than 0.1-0.2% per trade. At this stage it is important to understand that the system works and not to start making money immediately.
• The total risk of open positions should not exceed 10% of the deposit.
• If 20-25% of the deposit is lost, trading stops and the trading strategy is reviewed. Trading will then be resumed with as little risk as possible, so that within a few months at least we would understand that the new approach is profitable.

Easy money in trading

As much as we would like it, there is no easy money in trading. You can only lose it easily. One accident, one event, or one mistake can ruin your hopes, multiply all your experience and time spent on trading by 0.

The worst thing that can happen in trading is when a beginner, after repeatedly increasing his risk, accidentally makes a significant profit. For example, a month’s income from a single trade. This strengthens his confidence that he is doing everything right and therefore it is possible to open new trades with more risk. But sooner or later, the financial market will get its own way. And not just their own.

If your deposit grows smoothly and gradually, without any sudden drops or growth spurts, and you limit the possible losses, it means that you are doing everything right. This is the only way of preservation your funds and at most increasing your capital. A momentary profit on a random news, signal, or participation in a pump-and-dump group will never make you rich in the long run. Always remember that!