Crypto Academy / Season 3 - week 8 / Homework Submission post for Professor @yohan2on / Risk Management in Trading / by @ononiwujoel
Hi Professor @yohan2on, I am @ononiwujoel one of your students in Crypto Academy and a member of the steemit platform and this is my homework submission post from your lecture Risk Management in Trading.
Introduction
The crypto market generally is very popular for its high volatility and constant price movement swings which has made trading in this market a unique experience where a trader can be making huge profits one day and the next day be making terrible losses. So to be a successful trader in the crypto market, a trader must develop some skills that will enable him manage his loses in such a way that they remain minimal and don't lead to his account being impoverished overnight and this is where the concept of risk management in trading comes in.
Risk Management includes the different ways a trader can minimise loses on bad trades as he continues to pursue profits from good trades. So this concept is all about management of risks and loses to avoid them having huge impact on your account and this is our focus for this assignment.
1- Define the following Trading terminologies;
Buy Stop
Buy Stop is a very useful order that is used in an uptrend to make profits from the volatility of the market. The buy Stop order is placed just above the current market price or resistance in the market and will be executed once prices get to that point, it is placed above a resistance because usually when a resistance is overrun there is likely to be a bullish trend which will continue for a while and there is very little possibility of the price going back below the broken resistance. So this is a very advantageous strategy in trading to avoid losing in short term price swings in Crypto markets.
In the BTC/USDT chart above we can see an example of Buy Stop order being used. We can notice that the order was placed above the price at the time since the former resistance was at $40k, once the uptrend is able to push through the $40k resistance it will likely continue moving up and chances of it returning back to $40k are very little so in this way we are able to buy and make profits from the uptrend.
Sell Stop
Sell stop is very much like the Buy Stop order but this order functions the order way round, Sell stop order is used in downtrends to make profits from market volatility and minimise risk of losing in the downtrend.
The Sell Stop order is placed below the support line and will be executed after the support is broken and the price gets the the Sell stop order point.
This strategy although it looks like its on a losing end but will help a great deal in preventing serious loses in the downtrend. So it's a very clever way to keep your investment secure.
In the DOGE/USDT chart above we can observe that the Sell Stop order is placed below the support line because there is a downtrend and we won't want to loose all our previous profits in the downtrend, so by placing a Sell stop order at that point, when the decline breaks through the support and gets to that point, the Sell Stop order will be executed.
Buy Limit
Buy Limit is also a unique order that is used by many experienced traders due to it's efficiency. And it is usually used during an uptrend in market price.
This order is placed below the current price of the asset or below the resistance line that has become a support line so that whenever prices drop to this point, the order is executed and the trader is able to buy the asset cheaper in anticipation of a price swing after the temporary downtrend.
From the FXCM chart above we can see a well calculated placement of Buy Limit order at a point just below the support line that was also the previous resistance line knowing fully well that after breaking a resistance the price is likely to retest the resistance before continuing with the uptrend, so when it retest the resistance the buy limit order is executed and the trader buys at a cheaper price before the uptrend resumes and at such makes good profits from the price movements. So this strategy is also a very brilliant one.
Sell Limit
Sell Limit order is a direct opposite of the Buy limit order. It is applicable for both bearish and bullish trends although more useful during the former.
Sell Limit order is placed above the current price of the asset or better still at the resistance line or a little above it, so whenever the price gets to that point it will be executed and the trader will be able to make good profits from the trade by selling at a high price before there is a swing in direction of price movement.
In the TLM/USDT chart above we can see a good example of Sell Limit order. The Trillium token price here is on a downtrend which is likely to be a temporary one, so the Sell Limit order is placed just within the range of the resistance so that whenever there is a swing in direction of price movement and it gets to that point the Sell Limit order is executed and the tokens are sold before at a higher price than it's current price before another downtrend. So this too is a good trading strategy.
Trailing Stop Loss
Trailing stop loss is another advantageous type of order used for both bullish and bearish trends by expert traders. Trailing stop loss just like its name implies trails the price movement and locks in profits according to the percentage already set by the trader as the price continues to move in the direction anticipated by the trader but it stops the trade when the prices swings to an opposite direction and thus prevent loses and helps gather profits for the trader.
For instance, if a trader buys tokens worth $10 and uses the trailing stop loss order with percentage at 10% which is $1 that means when the price moves above $11 the profit of $1 will be locked in and it continues, but if the price then declines back to $11 the trade will be stopped by the trailing stop loss before it moves below that, hence preventing loss of profits.
Margin Call
Margin call is a concept very related to margin trading in most cases. This happens when a trader borrows part of the funds used in buying assets from a brokerage platform and then the trade sustain loses to the extent that it affects the conditions of the broker for traders and then the broker sends a message to the trader so he will have to either add more funds to fill up the margin or liquidate his investment to fill it up.
Like I mentioned before, margin calls is largely for margin traders that uses brokers to trade because this is one of the many benefits brokers offer users, they can buy more positions with combination of their funds and borrowed funds from the broker but it is based on some conditions. So if the trade moves in the right direction the trader will make multiple profits from both his funds and the borrowed funds but if the trade moves in an opposite direction the trader will have to pay for loses by depositing more funds or liquidating funds already invested
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 in Trading
The topic Risk Management in Trading cannot be overemphasised because recently there is widespread rising interests in the crypto market and other online trades especially cryptocurrencies and I can say more than 60% of the population joining the crypto market are newbies following the market noise and sentiments, so we have many traders only considering how to make profits like others maybe due to the FOMO mentality but not considering the risks attached to trading or how to protect their capitals. And this have made many people to loose all their money in just few weeks, some even in a day and then they give up on trading claiming it's too difficult.
But this can be easily avoided if they had knowledge of risk management in trading and how to sustain their accounts from getting blown through the ups and downs associated with market volatility.
Risk management in trading involves the different ways and strategies used by traders to manage their loses and risks while pursuing the profits and in that way prevent their capitals and already made profits from getting wiped out by some bad trades because in trading there will always be good and bad trades.
This concept has given birth to several techniques and tools which have been very helpful and saved many accounts from total bankruptcy. We will be discussing some of these strategies.
Portfolio Management (Diversification)
Management of your portfolio is actually the first strategy a trader should consider and what I mean here is diversification of investments. A trader should not be running a portfolio consisting of only one or two assets because that is equivalent to putting all your eggs in one basket and this is not only very risky but also makes profits very limited because all assets prices don't move at same pace or same direction so the trader will be robbing himself of many opportunities and also leaving his entire portfolio at the mercy of just one or two assets.
The image above is a screenshot of my Binance portfolio, although it's worth is very little it is still deversified.
So traders are advised to invest in several different assets so to minimise chances of losing your funds in few bad trades and also maximise your chances of making profits from different assets.
Consistency / Self Control / Sensitivity when using Leverages
Another strategy which is very important for traders comes from the emotional side of trading. Most time traders are not consistent with the strategy they apply and end up creating bigger risks anytime the market prices are moving in their desired direction in other to make bigger profits but this can result in a disaster if there is a sharp price swing and then make the trader loose huge amount of investment which he may never recover from again. So consistently and patience is very much required for successful trading.
Another aspect to consider is the use of leverages offered by brokers. This is a very welcome development and has benefited many traders who have made amazing profits from margin trading but in as much as the rewards are multiplied, the risks are also multiplied. So traders should not be in a hurry to use leverages and should be very sensitive and calculative when engaging in margin trading by first performing all necessary technical and fundamental analysis before starting this venture.
1% Rule, Risk/Reward ratio
In my opinion, the 1% Rule is a must for every newbie or average trader (I fall into this category too) because traders in this category are more likely to get carried away by market noise and negative mentalities and hence make avoidable mistakes in investments and Trading.
This rule requires a trader to set the amount funds they're willing to loose in trading to 1% so that if the trade runs loses more than that the trade is stopped.
For example if a trader enters a trade with $200, then he will set $2 as the amount he is willing to loose should the trade go south and as such protect his capital from getting lost in market volatility.
The Risk/Reward ratio is also another good strategy for traders. In trading, the amount of risks is very much related to the amount of profits so at times traders can be considering the profits but ignore the risks and can cause lots of loses. But with the Risk/Reward ratio a trader can set amount of risks versus the amount of rewards he is willing to take. This can be 1/2, 1/3 or 1/4 depending of preference.
For example, if the risk/reward ratio of a coin worth $100 is 1/2 then the trader will be making $20 profit if the trade is positive and will also lose $20 if the trade goes the wrong way.
Same thing applies, if the trade is 1/3, the trader stands to gain $40 or loose same $20 and it goes on.
Stop loss and Take profit
The Stop loss and Take profit are also very useful strategies for trading, especially in markets with high volatility like cryptocurrencies and crypto tokens and they work very well together.
Stop loss is an order used for minimising loses in a trade by discontinuing the trade once it gets the point where the Stop loss is placed. This tool is very advantageous especially when applied correctly but there are also cases where the Stop loss ends the trade prematurely and after ending the trade the prices swings direction and start moving in the right position hence making the trader loose out.
Take profit order on the other hand is used to end a trade when the prices gets to certain point as directed by the trader where the trader believes he has made enough profits and hence stops so as to prevent losing the already made profits in another change of direction of price movement.
Now these two can work together on a single chart to help secure profits and minimize loses at the same trade. And this is actually what most experienced traders do.
Using Moving Averages for Risk Management
From the TRX/USDT chart above we can see an example of using indicators like the EMA for Risk Management.
Now supposing I buy a this asset at the current market price in the chart which is around $0.08725 and then place my stop loss at 0.08500 and the Take profit order at 0.09500, the risk/reward ratio is calculated as;
Risk = Buy price - stop loss = 0.08725 - 0.8500 = 0.00225
Reward = Take profit - Buy price = 0.9500 - 0.08725 = 0.00775
So therefore, Risk/Reward is 1/5
Conclusion
Risk Management skills is one of the secrets and several successful traders given the fact that every trade will not go in the direction your desire, sometimes it moves in your preplanned direction other times it moves otherwise so there is always times of making good profits and also times of enduring loses but a good trader should be knowledgeable in managing his loses from bad trades so that they end up ruining his entire account which he built overtime. So this topic is a very useful one for every trader
It was a great lecture and I learnt a lot
Cc: Professor @yohan2on
To the attention of proff @yohan2on this post hasn't been graded nor upvoted and it four days gone.
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This is good work. Well done with your study on Risk management.