Dynamic Risk Management In Crypto Trading.

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In this fast-growing world of cryptocurrency trading which is known for its volatility, risk management has shown great and sustainable success in assisting traders experience less losses. In today's post, I will be exploring the key principles of risk management, showing how you can calculate risk-reward ratios, use volatility indicators-, and develop some risk-adjusted strategies. I will also explain some real-life lessons that were experienced from poor risk management and highlight some key takeaways and best practices.

1. Foundations of Risk Management.

In the cryptocurrency market where the price swings can be extreme, the principles of risk management are very important for traders to reduce losses. I am going to be talking about three foundational practices of risk management in the cryptocurrency market.

1. Position Sizing: this practice enables the trader to determine how much capital can be allocated to a single trade. Here, the size of this position is based on the overall volatility of the asset and the risk tolerance. In other words, if a trader trades the Steem/USDT coin which is a highly unstable asset, the position size must be smaller to reduce any potential losses. For Example, if a trader's total trading capital is $5000 and is willing to risk 2% on a single trade, the risk per trade is $100. The appropriate position size can be calculated using the risk per trade by determining the distance of the Stop-Loss.
   That brings me to the next practice which is Stop-Loss Placement.

2. Stop-Loss placement: this is an automatic exit from a trade when the price is going against the trader. When the stop-loss is placed properly, it can prevent the trader from getting a huge loss. Using volatility indicators like Average True Range(ATR) or resistance levels can assist the trader in understanding the technical analysis of the Stop-Losses placement. For Example, if Steem is currently trading at $0.35 and the trader after going through the technical analysis, indicates strong support for Steem at $0.30, the stop-loss can be placed at $0.28 to prevent too much loss if the price breaks below the stop-loss mark.

3. Lastly, Diversification which is an essential practice that helps reduce the rate of risk. This involves diversifying your crypto assets across other assets-, and allocating some of your capital to crypto assets like Bitcoin or any traditional assets. For instance, a trader can allocate 30% of his capital to BTC, 20% to ETH, and 50% to Steem. This will reduce the impact of any significant drop down of any assets rather than incurring more loss when he places all his capital on Steem.

2. Calculating Risk-Reward Ratios.

The Risk-reward ratio is a very crucial metric when it comes to crypto trading, this enables traders to gain access to whether their potential reward is going to justify the risk of entering a trade.

The formula to achieve this is very simple:

Risk-Reward Ratio = Potential Loss / Potential Profit

OR

Risk-Reward Ratio = Potential Profit / Potential Loss
​
To demonstrate the above with a practical example, I will be using the Steem/USDT data.

if the Entry point of a Steem/USDT trade is set at $0.30 which is the current price of Steem and the Stop-loss is set at $0.28 which is 2 cents below the entry price. The trader's Target price should be $0.40 which is 10 cents above the entry price.

To calculate the Risk-Reward ratio, we first get the Risk and Reward marks.
The risk is calculated as $0.30 - $0.28 = $0.02.
The reward is calculated as $0.40 - $0.30 = $0.10.
So, the risk-reward ratio is:

Risk-Reward Ratio = 0.02 / 0.10 = 1:5

Risk-Reward Ratio = 0.10 / 0.02 = 1:5

This means that for every $1 the trader risk, He stands to gain $5. Which is very favorable to the trader.

3: Leveraging Volatility Indicators.

Leveraging on volatility indicators helps in carrying out technical analysis and indicators like Bollinger Bands help to manage risk in the market. they assist in guiding the stop-loss placement and the position size.

Bollinger Bands: This indicator consists of two bands, the standard deviations above and below the average and the moving average. it indicates the overbought signal which is when the price touches or exceeds the upper band and signals the oversold condition when the price touches or exceeds the lower band. for instance, in the chart below the price touched the Bollinger Band at $0.311 which is a signal to tighten the stop-loss or reduce the position size, as a reversal might be imminent. Conversely, as the price approaches the lower band at $0.27, it suggests an oversold condition which indicates a potential buy opportunity.

4: Developing a Risk-Adjusted Strategy.

In order for the Steem/USDT market to successfully adapt to different market conditions, a successful trading strategy needs to be developed and this can be achieved by incorporating a risk-adjusted principle.

One of the principles I will be talking about is the consolidation period. this is when the market is ranging and the position size is slightly increased, the stop-loss can be tightened price fluctuations are typically smaller. For instance, from the chart below, the consolidation period in Steem/USDT shows that while the price is bouncing between $0.2684 and $0.2705, to reduce a significant risk of breakout, you might take a larger position with a tighter stop-loss.

5: Lessons from Real-life Scenarios.

Risk Management is one of the major reasons why some traders encounter significant losses while trading cryptocurrency. Now, let me talk about a real-life scenario that I encountered.

A few weeks back, I bought 5,000 Steem at $0.30 with no stop-loss set, expecting that there would be a significant rally. However, the market crashed and Steem fell to $0.25. I held onto the position without still setting a stop-loss because I was hoping that I would recover the asset. As the loss continued to mount, I eventually exited the trade at $0.20 incurring a loss of $1000.

Now, from this scenario, what I figured I did wrong was that I violated several key risk management principles:

First, I risked too much of my capital on just one single trade thats the position size.
secondly, I didn't use a stop-loss for me to be able to limit losses.
Thirdly, I failed to diversify my portfolio by sharing my capital with other crypto coins.

The Key takeaways from this scenario are:

1. I have to always use a stop-loss order.
2. Place my position size properly to avoid overexposure to my single trade.
3. I make sure to diversify my assets spreading the risk across other coins.

In Conclusion, for a trader to achieve a successful trading strategy, Risk management is very crucial in the cryptocurrency market, especially in the unstable Steem/USDT market. Incorporating some of the risk management practices like position size, placement of stop-loss, diversification of assets, and using volatility tools can assist traders navigate the unpredictable crypto market better. Lastly, learning from my past loss scenario has enabled me to adjust good market strategies based on the conditions of the market and also enhance long-term profit.

All Screenshots shared were taken by me

Thanks.

@chant
@wuddi
@simonnwigwe