Continuing learning in cryptoacademy, today i am writing homework post for professor @yohan2on which is about risk management strategy.

Introduction

Different trading platforms offer different trading options and different types of Orders which can be placed. Each of these orders has specific peculiarities. We are all aware of market order. In addition to that, trading platforms offer other four major types of orders and they are limit, stop, stop limit, and trailing stop.

To facilitate smooth transition into this task, I think a brief mention of market order is mandatory and then we will progress into the specifics of this task for better understanding.

Market order simply refers to placing a buy or sell order at the market price and market price is the price that is existing in the market at the time of placing the order. In case of market orders, we all may have experienced that, most of the time there is some difference in the price at which we place the order and price at which the order gets executed and that is known as slippage. So market orders are subjected to slippage risk. On the contrary market orders have the advantage of getting executed instantly. Execution of market orders also depends upon the liquidity or volume of the traded asset at the time of placing order.

BUY STOP

Buy stop refers to buy stop order. So let's understand the concept of stop order. in case of stop orders, we will have to understand the concept of *Regular stop order * amd Stop limit order. These are the two types of stop orders.

In case of regular stop order, we have to set only stop price and place the order. Stop price is different from market place. When the price of an asset reaches the stop price, the order will be triggered and gets executed at market price. Market price may or may not be equal to stop price. This point is important in volatile markets because of high volatility , when order is triggered at the stop price, by the time order gets executed , due to high volatility price may have either crossed above or below the stocp price , so there is possibility of order getting executed at a price higher or lower than the stop price.

In case of Stop limit order , we have to set two prices "stop price" and "limit price". When the price of asset reaches the stop price, order will be triggered but it won't get executed till the time price reaches "limit price".

Now coming to the "Buy stop". So it may be buy stop order of either regular type or stop limit type. In case of regular buy stop order , we would buy a token at a stop price which may be lower than the market price at the time of placing order to accrue more benefit and when the price reaches the stop price level , order will get executed at the market price. Where as in case of , buy stop limit order , we will place an order with "stop price" and "limit price". When the price reaches the stop price level , order will be triggered and if the price reaches the limit price , then and only then our order will get executed.

So stop limit order is basically the combination of two orders, stop order and limit order. Order is triggered at the stop price and executed at limit price.

Supporse, i want to buy 1 BTC .i checked market and found price of BTC as $45000 but i am not willing to buy at this price. I want it at lower range. So i decided to place "regular buy stop order". I choose stop price as "$40, 000" And placed order. After sometime, price of BTC dropped and reached $40 , 000. Order will be triggered. If market has enough liquidity and low volatility, order woll be executied at same price . If liquidity was low or volatility was high, order will be executed at slightly lesser or better price depending on the fluctuation of price once triggered.

Another scenario is that, i place a "buy stpp limit order ". So the two price that i choose are, stop price of $44000 and limit price of $44,500. So I'll have to wait for the price to reach $44, 000 so that my order will be triggered and for execution of the order price has to reach $44500 . If price reaches $44500 my order will be executed at the same price but if price failed to reach $44500 , my order won't be executed even after getting triggered.

SELL STOP

"Sell stop" may be sell stop order of either regular type or stop limit type. In case of regular sell stop order , we would sell a token at a stop price higher than the market price at the time of placing order to accrue more benefit and when the price reaches the stop price level , order will get executed at the market price. Where as in case of , sell stop limit order , we will place an order with "stop price" and "limit price". When the price reaches the stop price level , order will be triggered and if the price reaches the limit price , then and only then our order will get executed.

So sell stop limit order is basically the combination of two orders, sell stop order and sell limit order. Order is triggered at the stop price and executed at limit price.

Supporse, i want to sell 1 BTC .i checked market and found price of BTC as $45000 but i am not willing to sell at this price. I want it at hugher range. So i decided to place "regular sell stop order". I choose stop price as "$46, 500" and placed order. After sometime, price of BTC increased and reached $46, 500. Order will be triggered. If market has enough liquidity and low volatility, order will be executied at same price . If liquidity was low or volatility was high, order will be executed at slightly lesser or better price depending on the fluctuation of price once triggered.

Another scenario is that, i place a "sell stpp limit order ". So the two price that i choose are, stop price of $46000 and limit price of $46,500. So I'll have to wait for the price to reach $46, 000 so that my order will be triggered and for execution of the order , price has to reach $46500 . If price reaches $46500 my order will be executed at the same price but if price failed to reach $46500 , my order won't be executed even after getting triggered.

Buy Limit

Buy limit refers to buy limit order. So let's understand the concept of limit order. Limit order refers to a type of order where you set your own price for the asset which is different from the market price. In case of buy limit, you place a buy order at a price which you are willing to pay for the particular asset or token which you want to buy. When the price of asset will reach that level , order will be executed automatically.

Suppose I want to buy 1 BTC and i checked that price of BTC is $48000 but I want to get it at $45,000 . As I want to get it at a price lower than the market price, so I'll place my order at a limit price of $45,000 . When the price of BTC will reach $45000 , my order will be executed. So the point we need to understand here is that, in case of buy limit order , we will have to wait for the market price to reach the limit price for the order to get executed.

SELL LIMIT

Sell limit refers to sell limit order. Having discussed the concept of limit order above, it will be easy to understand what is sell limit order . In case of sell limit, you place a sell order of an asset that you have at a price which is different from the market price. When price of asset will reach that level , order will be executed automatically.

Suppose I want to sell 1 BTC and i checked that price of BTC is $48000 but I want to sell it at $50,000 . As I want to sell it at a price higher than the market price, so I'll place my order at a limit price of $50,000 . When the price of BTC will reach $50, 000 , my order will be executed. So the point we need to understand here is that, in case of sell limit order , we will have to wait for the market price to reach the limit price for the order to get executed.

Trailing stop loss

Before understand the concept of "trailing stop loss", we should first understand the concept of "stop loss".

Stop loss order is an exit strategy to minimise loss in case of unexpected movement of price . Keeping the volatility and unpredictable nature of the stock or crypto market in view setting of stop loss is very important to after entering into any trade to avoid huge losses or blowing of account . For better understanding the concept of stoploss , let me give an example

Suppose i bough 1 BTC at price of $40, 000 in an introday trade with the hope of selling it at $40800 by the end of day. Now there are two possibiliies, one is to place a sell order at limit price of $40800 with stop loss at $39600. So in this case, i am setting risk reward ratio of 1:2 which is logical.

Another scenerio is to place a sell order at limit price of $40800 without stop loss.

Now, there are three possibilities, first possibility is that price of BTC went as expected and it hit our limit price and we got a benefit of $800.

Second possibility is that, market took an unexpected turn towards downside and price of BTC droppee and hit my stop loss of $49400 and my order got executed on its own . So I was kicked out of the market with the loss of $400 but it is anticipated.

Third possibility is extrapolation of the second possibility where I have not placed stop loss. In this case, as the market took unexpected turn and price of BTC went down and by the end of the day, suppose price reached $40000. In this case , I'll be kicked out of the market with the loss of $5000 which is about 13 time more than that in case of setting stop loss order.

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Now let me come to the concept of trailing stoploss. We know that trailing means "to move behind along with something ". So can we say, trailing stop loss is a stop loss moving with price. As seen in case of stop loss , SL has a fixed price compared to market price. Whereas in case of trailing stop loss, there is no fixed value but stop loss is placed at certain percentages below the market price and it keeps on fluctuating with respect to the market price of an asset for which it has been set

Let me explain, how it works. Suppose price of any token is 100$ and we enter in trade and set a trailing stop loss at 10 cents below , that is at 90$. After sometime we saw that price of an asset reached 120$, that is , 20 % increase, trailing stoploss will move to 110$ (20 cent inceease) . Now if the price of asset stopped rising and inturn dropped to 105$. Trailing stoploss won't move but price would penetrate it and order would be executed at 110$ , yielding us a net profit of 10$ dollars.

So trailing stoploss moves with upward movement of price but not with downward movement. Had it been moving with downward movement of price too, it would have been harmful.

However, we need to be careful while setting trailing stoploss because some stocks are highly volatile and keep on swinging wildly. In those scenario, trailing SL may be hit before reaching your actual target. It is also advisible, to customise trailing SL, in case price makes new hugher highs. In such cases, we may decrease percentage of SL like in above case from 20% to 10% , so as to maxmise profit and also allow some flexibility in price swing.

Margin Call

We know that in case of introday trading brokers give traders certain margin but for that traders have to keep certain amount of funds in their margin account known as maintenance margin. Value of maintenance margin is different for different brokers.

Margin call is a warning or alert message from the broker for the trader warning him of decreasing value of his margin account below the value set by the broker . It may be due to loss in the trade or decreasing value of the asset in the trade.

Margin Call demands trader to deposit more funds to bring the value of the margin account back to that demanded by the broker. In case, if the trader fails to deposit more funds to bring it to the maintenance level, the broker may trigger liquidation of the assets in the trade known as" forceful liquidation " so as to compensate for the maintenance margin.

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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).

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Risk Management

Risk management refers to certain strategic and objective measures taken by traders to avoid losses so as to survive in the market for long time. Risk management is also sometimes known as money management to avoid the psychological cloudiness caused due to aversion linked to the word "risk" . Traders have developed certain tools for risk management. We shall discuss these risk management strategies under following headings.

• Stop Loss and Take profit points.

• Risk - Reward Ratio.

• Risk per trade.

• Risk per day.

• Quantity.

• Diversification of Portfolio.

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Stooloss and take profit

Let's briefly discuss these tools. The concept of SL and trailing SL has been explained above with examples. So no need to discuss them here. In the example above, i have explained how an unexpected move can cause loss in a trade without stoploss much greater than with stop loss. So this is the first tool.

Take profit or target is as important as stoploss. We usually tend to greed and avoid setting take profit level. Not setting take profit can sometimes lead to loss of winning trade because crypto market is highly unpredictable. Despite judicious use of available resources like indicators and fundamental analysis, no body can predict the direction of market movememt with certainly.

Setting SL and TP levels clearly indicate that a trader has some trading plan in mind and as saying goes "Plan the trade and trade the plan." Setting SL and TP means that we had plan for the trade and we are trading the same plan. These are the key qualities of a successful trader. Without these points, our emotions tend to dominate us and we end up doing blunders like holding losses with the hope of profit later.

Risk Reward Ratio.

Risk reward ratio is a strategy to take leas risk for the sake of gaining more profit. To begin with, we can start with 1:2 ratio which means reward is twice the risk. It can later, increase to 1:3 or 1:4 .

Suppose we enter into a trade of a token where we bought a token that costs $10. We set stoploss at $8 and Take profit at 14$. Now, two possibilities are there, ether the trade will go in the direction as anticipated or will go against it.

If the trade goes in the direction as anticipated, it will hit our take profit level and we will earn profit of $4 per token. On the contrary , if it doesn't go as expected, our stop loss will be hit and we will suffer a loss of $2 per token. In this case , ratio of risk /reward is equal to 2/4 that's equal to 1:2 , which means that we are willing to lose $2 for the sake of gaining $4 , which a good strategy to begin with. Again it emphasises the importance of SL and TP levels.

Risk per trade.

As the name implies, it refers to amount or percenrage of total capital which you can afford to loose in each trade. Actually it depends upon your risk aversion strategy.

Suppose you have taken a trade of $100 and your RPT is 2% . It means that, you are willing to lose 2$ , in case trade doesn't go as expected.

Risk per day

It refers to maximum amount of capital that you can afford to lose per day. If you know the percentage, you can decide the number of trades that you can take in a day. Suppose your risk per day is 2% of your capital and you are setting a stop loss of 1%. It means that, in case your first trade of the day goes unexpected and your stop loss is hit , you can still take one more trade as per your risk per day strategy.

So RPD = RPT x No of SL hit .

Quantity.

Quantity of token to be traded is important parametre of risk management. We tend to oversize our position with the greed of gaining more profit without bothering about loss.
Mathematically, we can calculate it as :

Quantity = RPT divided by S/L number.

However, there is a theoretical rule for it and that is "One Percent Rule" According to this rule, we should not put more than one percent of our capital into a single trade.

Suppose our account worth is $1000 and as per this rule , we should not put more than 1% of 1000$ ( 10$) in trade. On the basis of this rule, we can calculate quantity. If the cost per token is 1$ , as we have to invest only 10$ , so we can only trade 10 tokens.

Diversification of portfolio.

Diversification of portfolio refers to investment of funds into multiple stocks or tokens. Avoid investing or trading into a single asset because in case of any adverse market movement, if portfolio is not diversified, one is vulnerable to suffering huge losses. On the contrary, if portfolio is diversified, the possibility of suffering losses in all the assets at a single point of time is very less and there is a possibility that loss in one asset may be compensated by profit in other assets.

Understanding Risk Management with Moving Averages.

All the tools mentioned above are important parameters of the risk management strategy and compromise in any of these weeken the sanctity of risk management strategy. So each of these factors must be given equal weightage for the formation of a solid risk management plan. However, as for my understanding is concerned, I think the two most important parameters of the risk management strategy are stop loss and take profit levels.

Multiple theories exist to determine these levels like setting SL and TP on the basis of support and resistance, percentage method , multiple days high/low method in case of Swing traders and most importantly the use of moving averages.

We know that the Moving averages tend to average out the price by taking average of the price over a particular time frame and represent it in the form of a line. Simple moving averages give equal weifgtage to the price over a timeframe choosen where as exponential moving average put more emphasis on recent price in the order of decreasing weightage from yesterday to day before yesterday amd so on.

Depending upon the type of trade you are taking, period of moving average is used. For example,
20MA in short term, 50MA in mid term and 200MA in long term trade.However, it should be subjected to back testing personally.

ETH/USDT 15mim chart

In the chart above , I'll be using exponential moving average 50 and 200 as i am using it on day to day basis and haave found it useful.

Entry : i enter after crossing over of 50 MA to 200MA from below upward.

Stoploss : Stoploss is placed just below the candle that cuts 200MA.

Take Profit: Keeping your risk reward strategy in view, TP can be set. usually consider 1:2 as a good strategy to begin .

In the chart above, entry is at ETH value of 2620 USDT, stoploss is at 2500 and TP at 2830. So risk here is of 120 USDT per token and TP is 230 USDT. So risk:reward = 1:2 ( approx) .

Conclusion

Risk management is a sound practice to sustain in trading world. It involves various vital tools but often ignored by traders. Most of the traders who complain of suffering huge losses and the reason being non complaince with the one or more of trading tools. So to stay profitable and minimise losses in trading, risk management is mandatory.

Thanks