Steemit Crypto Academy | S3-Week 8 | Homework post for @yohan2on - Risk Management in Trading
Trading in the cryptocurrency world is a technical act of speculating price movements of cryptocurrency assets. It involves the buying of cryptocurrencies at a lower price and selling off at a higher price with the aim of making profits, while at the same time minimizing losses. Diverse tools are used in order to prevent a gambling-kind of trade and instead be a seasoned speculative trader. One or more indicators are used to monitor trade in order to make wise decisions. Orders are also automated to execute when certain conditions are met. There are different types of orders which will be discussed in this post along with the measures used to manage risk involved with cryptocurrency trading.
1- Define the following Trading terminologies:
- Buy stop
- Sell stop
- Buy Limit
- Sell Limit
- Trailing stop loss:
- Margin call
- Buy stop: This is a type of order placed in a cryptocurrency trading session which helps traders participate in a cryptocurrency bullish trend. The buy stop order executes to help the trader buy a cryptocurrency when the value/ price of the cryptocurrency exceed the level at which the buy stop order is placed. In a very simple illustration, if the current price of an xyz cryptocurrency is $100 dollars, a trader can place a buy order at $150 because based on his analysis he predicts that if the value of the xyz cryptocurrency reaches $150, the market will become bullish and the xyz cryptocurrency will continue to increase in value. The buy stop order will help the trader to take part in profit taking in the bullish market.
- Sell stop: This is a type of order placed in a cryptocurrency trading session which helps traders prevent further loss in a cryptocurrency bearish market. The sell stop order executes to help the trader sell a cryptocurrency when the value/ price of the cryptocurrency falls below the level at which the sell stop order is placed. In a simple illustration, if the price of a certain cryptocurrency, abc is at $800 when the trader enters the market, he would estimate the amount he is willing to loss. This is usually not more than 20%. So he would set a sell stop order to sell off (or part ) of his abc cryptocurrency when the price goes below his sell stop order. In this abc cryptocurrency example, the trader is likely to place his order between $720 and $640.
- Buy Limit: This is a type of order placed in a cryptocurrency trading session which helps traders buy cryptocurrencies at a reduced price in a bearish market or dump. In a cryptocurrency trade, the trader who intends to buy cryptocurrencies at a reduced prices sets the buy order limit to buy at a lower rate. It is similar to the sell stop limit but instead of selling when there is a bearish market, the buy limit buys when the price of the cryptocurrency goes below the price in which it is set. For illustration purpose, if the price of a certain cryptocurrency xyz is $ 300. If the trader predicts the fall of the xyz cryptocurrency, he could set a buy limit to $150 so he can buy more cryptocurrencies for half the price than if he had bought the cryptocurrency at the current price. So if he has $10,000 to invest. He would get 66.7 xyz tokens by setting his buy limit to $150 than if he bought at $300 current price, in which he would get $33.3 xyz tokens.
- Sell Limit: This is a type of order placed in a cryptocurrency trading session which helps traders sell cryptocurrencies at a high price in a bullish market. This is similar to the buy buy stop but instead of buying when there is a bullish market predicting a further bullish market, the order sells the trader's cryptocurrencies. In this trade, the trader intends to sell at a high price, especially before the next bearish cycle. For illustration purpose, if the current price of a certain cryptocurrency abc, was acquired at the price of $10 each. Based on a trader's analysis, he might decide to set a sell limit at $30. Once the price of the abc passes $30, the order executes and sells the traders abc and he goes away with a 1:3 interest.
- Trailing stop loss: This is a type of order placed on crypto currency trading session which helps the trader maximize profits while minimizing losses. In the trailing stop loss is constantly altered in respect to the current asset value or price. As the price of the cryptocurrency rises toward the buy limit, the stop loss moves upward above its former position. For illustration purpose, if a trader enters a trade when the crypto currency asset value current value is $50 and he sets a trailing loss stop of 10%, which is is $5, the trail loss will be executed at $45. If the price of the crypto asset increases to $55, the trailing stop value alters and move to$50. If the value however reduces, the trail order limit won't alter and go downward. If the value increases to$70, the trailing stop value alters to $65 (still $5 trailing loss). If the crypto asset value decreases as much as reaching $65, the asset would be sold off.
- Margin call: This is a concept often associated with margin trading, though it can also be used with spot trading. Margin Call occurs when a trading account's asset has been liquidated and has no free margin to execute a trade. The trader now needs to add more assets to his account in order to continue trading (spot trading) or have access to leverage trading (margin trading). When a trader is performing a trade of 5x he might encounter a margin call but when he tries performing a trade of 2x, he wont encounter the margin call. In essence, margin call requires that the trader has a specific amount in his account to execute a specific trade.
2- Practically demonstrate your understanding of Risk management in Trading.
- Briefly talk about Risk management
- Be creative (I will expect some illustrations)
- Use a Moving averages trading strategy on any of the crypto trading charts to demonstrate your understanding of Risk management. (screenshots needed)
Risk management is defined as the evaluation of financial risk along with the recognition of procedures to minimize or if possible avoid their impact. Though it is impossible not to have losses in trading, the goal is to minimize losses while maximizing one's profit. Hence In cryptocurrency trading, it is important that a trader is able to apply risk management in order to prevent loosing his funds. There are various risk management precautions that can be taken by a trader in order to minimize losses in trade while maximizing his profit, these include but not limited to:
- Planning your trade ahead
- Position size your trade
- Knowing when to enter a trade
- Stop Loss and Take Profit
Planning your trade ahead
A person who fails to plan will automatically fail. This is not different when it comes to crypto currency trading. A trader need to plan his trade ahead as a risk management technique. When planning your trade, certain questions need to be answered such as:
- Which pair do you want to trade?
- What kind of trade do you want to engage in?
- How much do you want to invest in trading?
- How much profit are you expecting to take?
- How much are of your initial money are you willing to loose?
These questions can only be answered through detailed research performed by the trader. When choosing the pair to trade with, the trader will have to make technical analysis of different pairs and as well their fundamental analysis. This goes in line with the kind of trader a person wants to be. Does he want to be a day, a weekly or monthly trader?
How much is he willing to invest in trading? He need to plan this ahead and also know how much he is willing to loose. This will help him set a reasonable stop loss so he can exit a trade to avoid much damage in a bearish market. The advisable lose percentage should not be more than 20% irrespective of what the indicators are saying. There are exception to this rule though.
A trader need to plan and know how much profit he wants to take, this way he won't be carried away by greed in a bullish market which is often followed by a dump.
Position Size your trade
Position sizing is the specification of how much coins or token a trader is willing to buy. It is not advisable for a trader to put all his fund in a trade. For example, if a trader has $20,000. It is very unwise for the trader to use all the $20,000 in buying a cryptocurrency for a trade. He could spend between 30%-70%.
Position sizing is dependent on how much a trader is willing to loose, the past history of trading pair and the predictions from technical indicators.
Knowing when to enter a trade
It is important for a trader to know when to enter a trade and the right time to exit a trade. If you speculate bearish market which will occur soon, it is better to wait till then before entering the trade so as to earn more cryptocurrencies for less.
Stop Loss and Take Profit
It is paramount to use the order features on an exchange. One of the most important order to use is the Stop loss which helps sell off a percentage or all of a trader's cryptocurrency when its value goes below a certain price. This is in fact the most important step/ precaution in managing risks associated with trading. If a stop loss is not set, especially in margin trading, a trader can loose all his money.
Use a Moving averages trading strategy on any of the crypto trading charts to demonstrate your understanding of Risk management
A moving average indicator is one of the numerous technical indicator used in analyzing a trading chart in order to recognize when to buy or when to sell. The chart is forms a line by calculating the sum of data points within a specific period and dividing it by the sum of time periods. A trader needs to set two moving averages with different time periods, indication to buy or sell is shown when the two averages cross (this is known as the golden cross).
In this example, I'll be using binance to demonstrate how to use moving averages trading strategy for managing risk in crypto trading.
As show in the screenshot above, I logged into my binance account and chose the BTCUSDT pair. I clicked on the indicator menu on binance so I can add the moving average indicators.
On clicking the button, an interface opened and here I checked the moving average box by the left, the I added two moving averages, the first one with a period of 21 and the other with a period of 100.
The golden cross at 39,860.00 usdt signaled a time to buy BTC as shown in the screenshot above. I executed a buy, entering the trade at a price of 40,000.00 usdt. Using a resistance level, I set a stop loss at the price 34,407.00 usdt which is a loss of 5,593.00 usdt (approximately 14%)- this is still below the 20% maximum-loss rule. I set a sell limit at a resistance level of 51,170.00 usdt which is a profit of 11,170 usdt (approximately 30% gain).
What is my risk/reward ratio?
Risk/reward ratio is the a calculation which compares the level of risk of a trade with its potential return or profit, helping a trader determine the profitability of the trade. The rule is the riskier a trade, the more profitable it is. The formula for calculating the risk/reward ratio is:
Entry Price = 40,000usdt
Target Price = 51,170usdt
Stop loss Price = 34,407usdt
Risk/Reward = (Target Price – Entry Price) : (Entry Price – Stop Loss)
Risk/Reward = (51,170 – 40,000) : (40,000 – 34,407)
Risk/Reward = 11,170 : 5,593
Risk/Reward ratio = 2:1
This trade is a profitable one, though not as profitable as having a ratio of 3:1 or 5:1 which comes with high risks of loosing a lot of money. The most important rule in risk management is to learn to be contented. However, there are places for for the take/risk.
Conclusion
In essence, different procedure exist to help manage risk while trading cryptocurrencies. If these rules are followed, the chances of remaining a trader, and a good one at that is maximized. Indicators help to speculate the movement of the market and tools like orders help a lot in risk management.
In this post, we discussed the popular order types which include the Sell limit, Buy Limit, Sell Stop, Buy Stop and Trailing stop loss.
- A buy stop help a trader join a bullish market. He sets the sell limit at a price which he believes indicates that will market will continue to be bullish
- A sell stop help a trader sell off his crypto asset as the market experiences a bearish cycle
- A buy Stop helps a trader buy assets in a bearish market
- A sell stop helps a trader dump an asset as it experiences a bullish cycle
- A trailing stop loss is used to minimize loses by altering the sell limit as asset price increases.
Proper risk management will help a trader maximize profit taking and minimize losses.
Thank you!
Hi @damzxyno
Thanks for participating in the Steemit Crypto Academy
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This is good content. Well done with your practical study on Risk management.
Thank you @youhan2on