When deciding to trade a cryptocurrency, it can be instinctive to spend a lot time choosing an entry point which fits a strategy and setup targets to lock in those profits!
But, how often do you set a stop-loss?
In this article we are going to look at the impact that employing an effective risk management strategy and utilizing Stop-Losses can have on your investment.
"The elements of good trading are: 1) cutting losses, 2) cutting losses, and 3) cutting losses. If you can follow these three rules, you may have a chance" Ed Seykota
Once subscribed to a trading strategy, it's essential to calculate how often a win can be expected when using the method on the open market.
An essential ingredient of an effective risk management & trading plan is being able to know how often a trading strategy should succeed or fail.
This will help us determine the size of our trades.
Win Rate(%) = (Wins / Total Trades Made) x 100
Risk/Reward Ratio (R)
The next step is understanding the trade opportunity, and what the expected outcome will provide through comparing the Risk and Reward of the trade.
Using the Swyftx Trading Charts, select the Long Position tool.
Looking at the position tool, there are Three Metrics we are interested in.
(1) Risk/Reward Ratio (R): a ratio of the opportunity we've speculated
(2) Profit Target
(3) Stop Loss Target
Using this information we can start to setup our trade.
Download the Free Swyftx Position Size Calculator, and use this information to assess what is an appropriate entry size is based on your account size and risk allowance.
Impact of Risk Allowance on Equity over Time
To visualise the impact of what this all means, below are some examples of why measuring and planning trade outcomes is important. The data in each scenario presented below has been extrapolated over 250 trade events with each strategy. Each is run with the same parameters, with only an alteration in the Risk Allowance to demonstrate how the growth of the portfolio is managed over time when employing appropriate risk management strategies.
Strategy 1a -Win Rate 55%, Risk:Reward (R) value of 1, Risk Allowance 2% on a $20,000 account
Strategy 1b - Win Rate 55%, Risk:Reward (R) value of 1, Risk Allowance 20% on a $20,000 account
Strategy 2a - Win Rate 35%, Risk:Reward (R) value 2.5, Risk Allowance 2% on a $20,000 account
Strategy 2b -Win Rate 35%, Risk:Reward (R) -value 2, Risk Allowance 20% on a $20,000 account
From the two example strategy/trading systems scenarios above, using a random number generator we are able to measure & visualise the impact varying your risk management levels can have on your investments over time.
Remember that the goal here is to ensure the overall impact of capital loss on your investment is minimal, as even with a trading system, there are periods of profit as well as draw down in the market. This is what minimising your risk is all about, to ensure that you are not caught unprepared when the market drops.
Once your investment capital takes a substantial hit as a result of these events, it can be an up-hill battle to make up for the short-fall.
The table below shows that once you pass a 50% loss on your initial investment, a 100% profit gain is needed to get back to break-even on your initial investment.
Loss of initial Capital %
Gain % Required now to Recover Loss
As demonstrated above, even a trading strategy with a 55% win rate can prove to be a profitable method of investment if the appropriate risk management strategy is applied to limit your losses.
Through back testing your strategies, seeing how often they may have worked in the past, determining your Win-rate and finding the minimum Risk/Reward Ratio (R-value) you can ensure that your trading plan will remain profitable in the long run!
For more information on how to place a stop-loss and employ an effective risk-management strategy, please click here.
The content provided is informative in nature and provided for educational and entertainment purposes only and is not and should not be construed as professional financial, investment, or legal advice. Application of information or trades placed are taken at your own risk based on your own Due Diligence.
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