In our previous article we discussed the key reason 95% of traders lose money and quit trading. The reason turned out to be simple – their trading strategy lacked risk management that is exactly the right tool to stay in-game and multiply your profits.
The next question is, obviously, how exactly to be that 5% of traders that reach their trading goals and become millionaires? In other words, how to build a reliable, consistent risk management system?
From the very beginning, it’s worth mentioning that the risk management system is not about a single stop loss, it’s a system that enables us to monitor, calculate, control and limit losses to ensure stable earnings. By the way, this approach to trading is widely used by hedge funds aimed at long term profitability. Thus, here are the 4 secrets that can make you extremely profitable! Let’s break them down:
Secret 1: Monitor
Risk management starts with the awareness of your trading performance. To improve your strategy you need to know the details of your trading. Hence, gather and systematize your trading statistics (gains, losses, profitability and so on) manually or with the help of the special software to save time and avoid human mistakes. An example of automated statistics is presented below. Thus, you can review your performance and assess it within smart real-time charts.
Or if you don’t use any software, at least track your stats in excel.
Secret 2: Evaluate
The statistics is not enough for adequate trading evaluation. A single profit rate won’t help you to assess objectively the effectiveness of your trading strategy. Therefore, it’s essential to calculate and constantly monitor key trading performance metrics, for instance, maximum drawdown and profit factor.
Secret 3: Control
With the help of stats and trading performance metrics keep in control of your trading setups:
- Position sizing. Make sure you recalculate your position sizing with the deposit growth (no proportional increase please!) or if you change your strategy. Position size is individual for each setup. Otherwise, the strategy turns out to be ineffective.
- Risk-reward ratio (stop loss and take profit ratio). The risk-reward ratio should also be recalculated each time you change your strategy and the position size. It may bring profits in one trading setup, while losses only in others. Read about it here.
- Leverage. The same works with leverage. Calculate and choose a reasonable leverage size, depending on your trading strategy. Note that leverage higher than 16 is considered to be risky already. Then, what about 100x? Take care!
- Regular strategy adjustments. The market state changes, making even super successful strategies fail. Keep up with the market and correct your strategy timely (trading stats and performance metrics will indicate you the right time to do it).
Read more about controlling these risks here.
Secret 4: Set risk limits
Overconfidence, fear, hope, greed and many other emotions distract traders from complying with their trading plans. You start widening your stops or overholding losing positions and may miss the moment when you run out of funds. The diversions from trading strategy result in losses that mean more emotions, more diversions and more losses. Vicious circle.
Therefore, set the trading limits on a daily, weekly and monthly basis (just like a trader A did). Risk limit is a share of your current deposit that you afford to lose in terms of your finance and psychology. Thus, distinguish the limits that you won’t exceed and strictly comply with them to survive in the market.
Thus, determine the limits based on your previous trading performance. The limits can be set for:
- Overall deposit drawdown (20% is often used as a limit by many traders)
- One trade loss (generally, it is 1-2% from your deposit)
- A row of losing trades
- A period of time you hold losing position
If any of the limits is reached, stop trading for some time. This way, you stop the losses before they destroy your account, give you some time to calm down and probably adjust your strategy. Again, you can do it manually or use automated risk management. For example, with Bitinsure, you can set risk limits for your deposit for several accounts that will be tracked 24/7. Thus, in the case of this limit reached, the service will send you a security alert to email or Telegram or even close the position automatically (depending on your tariff). Read about how to configure your risk limit here.
As you can see, these 4 steps can take your trading to the next level. Risk management protects your deposit by powerful math, limits your losses and helps to control emotions. However, note that effective risk management requires enormous discipline to comply with all the rules and control the trading metrics. Congratulations if you manage to do it manually! But note that manual risk management is tied to human mistakes and lots of time consumed.
That is why, after we explored the common pains of traders, we developed an automated risk management system that covers the majority of the steps we discussed. It gathers the stats without human mistakes, calculates the metrics, monitors them 24/7 and makes you aware if any of the limits are reached (instant security alerts). Desktop and mobile versions are available.
Try Bitinsure for free and improve your trading now (the instructions are here)!
Remember that any losses can be cut and turned out into the profits!
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