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Buying and selling digital currencies as a way of producing extra income is becoming more and more popular with an innumerable amount of people deciding to take part. However, in order to ensure success with this new income source, one must practice what is known as strict risk management. Proper management of risk can often be the decider between making money at the end of the month and losing money. In this article, we will explore some risk management techniques that are fundamental in order to make it as a trader.
Stop Losses and Take Profit Targets
The first thing a trader must do when trading is to use what are called stop losses and take profit targets. Stop losses are paramount as they can often act as a barrier to prevent further losses if a trade is not going well. On the other hand, take profit targets permit a trader to lock in gains if a trader is going well, something that you must ensure that you do.
The lack of a stop loss or take profit target will always prohibit a trader attempting to be profitable at the end of a month. As an example, if no stop loss is placed, it very easy for a trader to fall prey to their emotion and refuse to close a trade simply because they believe it will turn around. Crypto trading bots and signal groups (e.g. crypto signals) are useful tools in allowing traders to implement both a stop loss and a take profit target before entering a trade, therefore, taking the need to make such a decision out of their hands.
Position Sizing
Moving on, an additional key risk management technique is something called position sizing. The simple idea behind position sizing is to use an acceptable amount of your capital for each trade, you should not for example use 100% of your balance. This suitably protects a trader’s capital should a trade go wrong. What a trader should be doing is instead using a small percentage of their entire balance, e.g. 5%. This allows a trader to factor in any unforeseen market changes that may affect a trade.
Risk/Reward Ratio
The third and final risk technique that all traders should be looking to implement in their trading is the simple concept of risk/reward ratios. At a basic level, a trade needs to return more if the take profit target was to be hit that if the stop loss was to be hit. This simple act will, in the long run, result in the trader being more profitable even if they don’t get 100% of their trades correct. The important teaching here that you need to understand is simple: only enter into a trade where the risk/reward ratio is positive and never negative.
The formula for calculating risk/reward is as follows:
(Target – entry)/(entry – stop loss)
Below is a useful guide for understanding what a good and bad risk/reward ratio look like.
- 1:1 is breakeven
- 1:2 is great to trade
- 1:3 is even better and maybe a perfect ratio
Anything less than a 1:1 risk/reward ratio is negative and therefore is not a trade that should ever be taken unless you really know what you’re doing.
Conclusion
To conclude, you often don’t need to be an expert trader to have good risk management practices. It’s just that new traders tend to get impatient with these teachings and prefer to do it their own way. It is highly recommended that you take the time to understand these risk management principles and understand how you can incorporate them in your own personal trading.
Disclaimer
The views and opinions expressed in this article are solely those of the authors and do not reflect the views of Bitcoin Insider. Every investment and trading move involves risk - this is especially true for cryptocurrencies given their volatility. We strongly advise our readers to conduct their own research when making a decision.