The Ultimate Blueprint For Risk Management (FULL GUIDE)
Hello Traders!
If you don't know who I am, my name is Jacob Canfield and I'm one of the top authors on Trading View. I've been trading various markets since I was 19 years old when I bought my first options course.
After spending a decade trading in all types of markets and spending the last 3 years in the cryptocurrency markets, one thing is certain... risk management gets thrown out the window when it comes to crypto (and okay, Forex too... you know who I am talking about you margin trading degenerates)
When the terms MOON, REKT, and FOMO are the most popular phrases when trading an asset class, you know that it's doomed from the start.
Well, I'm here to change all that.
I'm introducing my FREE technical analysis series for traders and if this gets a good response... *cough cough* Go like this chart right now *cough cough*...then I will continue the series.
The BEGINNING chapter in any series should always start with understanding risk management!
I'd appreciate it if we could get this chart this trending to #1 (and you can help me do that by liking and sharing this chart) because EVERY SINGLE TRADER needs to understand these concepts, ESPECIALLY if you're new and ESPECIALLY if you're trading highly volatile markets like crypto.
I take trading very seriously and as they say in any sport, a good offense is the best defense. If WINNING trades is the offense, managing your risk is the defense.
It's more than just protecting capital, it's about STAYING IN THE GAME. Most markets have their 'peak bull runs' that last only 30-60 days out of the year.
That means, for the rest of the time you're trading, you want to manage your risk as much as possible to capitalize on those massive upswings when they do come.
Let's dig into all the terms and as we're going through... you'll get to understand how ALL these concepts work together.
ENJOY!
PORTFOLIO:
RISK PER TRADE:
Risk Per Trade gets often confused with 'position size,' and this is the farthest from the truth. I hear all the time people say... "only risk 1%," but if you have $1,000 account.. risk 1% would only be $10, which wouldn't even pay for the fees. Risking 1% means that you're willing to lose $10, which means you can use your entire portfolio with a 1% stop loss.
Important NOTE on amount of Risk Per Trade as balances go up and down:
- If your balance is going up, then the amount goes up with it.
- If your portfolio is going down, then the amount risked goes down with it.
1-2% Is a standard risk per trade for professional traders.
1% of $1,000 = $10
1% of $5,000 = $50
1% of $10,000 = $100
1% of $100,000 = $1000
USING STOP LOSSES:
DRAW DOWNS AND RECOVERY
If you lose 5% on a trade, it takes a 5.3% winning trade to get back to break even.
If you lose 10%, it takes a 11.1% winning trade to get back to break even.
If you lose 30%, it takes a 66.7% winning trade to get back to break even.
If you lose 50%, it takes a 233% winning trade to get back to break even.
If you lose 70%, it takes 400% to get back to break even.
If you lose 90% (like everyone hodling through 2018), it takes a 900% winning trade to get back to break even.
The likelihood of hitting a 5.3% winning trade is astronomically higher than hitting a 900% winning trade, which is why we take risk management so serious.
POSITION SIZING:
Percentage Of Your Portfolio To Risk When Factoring in the Stop Loss.
Divide that money amount by the price of the crypto.
This gives you your lot size to purchase to manage your risk.
Number of lots/contracts you buy or sell.
A SIMPLE CALCULATION USING BTCUSD
How do you calculate the 'lot size' after you know your dollar amount for your position size... well, that's easy.
You take the position size and divide it by the entry price of the asset you're planning on trading.
In this case, it would be Bitcoin. The current price of
BTCUSD
is $3800.
So, $5,000 divided by $3800 gives you a 'contract' size of 1.315 Bitcoin for this specific trade.
ANOTHER CALCULATION USING BTCXRP (for Bitcoin Portfolio's)
In order to calculate how many XRP you should be buying, you divide 2 BTC by the price of
XRPBTC
, which is 0.00008200 sats. (satoshi's)
Compounding Effect of Losing and Winning On Your Position Size:
As you lose trades, the position sizes become smaller because the portfolio % scales down with your losses.
As you win trades, the position sizes become larger because the portfolio % scales up with your wins.
RISK/REWARD RATIO
The reward-risk ratio is equivalent to the reward (take profit) divided by the risk value(stop loss).
Usually represented by a ratio or a number.
Example: 4:1 = 4 to 1 risk reward. (or 4 R:R)
This also represents how fast winners offset losses.
It's a simple calculation:
Example:
Buying Ethereum at $100.
Your stop loss is $90 and your target is $120.
Reward/Risk = R:R ratio
$20/$10 = 2 R:R
ANOTHER EXAMPLE OF RR:
The importance of RR is that by having a higher Risk/Reward ratio value, the less number of winning trades you need to remain profitable.
What is Evolving R?
When you first enter a trade, your risk/reward is a static number that is very linear. 1:1, 2:1, 4:1 etc.
As the trade develops... either into profit or into loss, the R starts to change.
Let's say your trade moves in favor of you and your take profit is 4:1 RR, but you are currently at 2:1 RR.
Evolving R states that your NEW RR is 2:1 and your former stop loss is now a 1:2 ratio. This is where we don't want to give back profits to the market and we want to trail our stop loss or start to scale out of the position.
This is the importance of monitoring your trades as they evolve rather than taking a completely passive approach.
Evolving R is a concept derived from TraderDante I believe (a well known Forex Trader and pioneer/godfather to almost every 'price action trader on crypto twitter.)
Let's take a look at an example of evolving R.
We took a short on Bitcoin with a static RR of 5.5 and here is where the trade is at.
Now, if we evaluate our current trade position with where our stop loss is at, the evolved R as the trade has progressed is now this:
This gives us a new RR of .86 if we let the trade go all the way back to our entry zone and stop loss. This is less than a 1:1 RR on this trade.
As an active trader, we want to make sure we are constantly re-evaluating our trade set-ups to ensure proper RR as the trade evolves.
In this trade, a good strategy would be to trail your stop loss to lock in profit and maintain a strong RR as the trade moves towards our original target like this:
This gives us a continued RR of 2.41 and our stop loss is above the recent swing high in case the trade moves against us back to our original buy in zone.
Evolved R is a concept you always want to keep in mind as the worst thing to happen is miss your target by 1-2% and have it come all the way back down and hit your stop loss.
WIN RATE
How many trades you won over a specific time period.
Most common time frames traders measure are weekly/monthly/quarterly/annually.
Lower R:R usually requires a higher win rate to stay profitable.
A Higher R:R usually requires a lower win rate to stay profitable.
This is why knowing your win rate helps you know how much you can risk on trades.
The Risk/Reward has a correlated relationship with Win/Rate
Let's Put It All Together To Make It Simple:
I have $5,000 and I want to ONLY be in 5 active managed trades. I would allocate $1,000 to each individual trade and then I would decide on how much I want to risk per trade. Let's say it's $30 (30%).
As I was monitoring the market, I found 5 set-ups. As I find the set-up I want, I calculate my stop loss first and then I calculate my position size.
In this scenario, each trade has a 2:1 RR for the take profit target zones.
Here are 5 hypothetical sample trades that I took:
Trade 1: 4% risk with 8% target
Trade 2: 9% stop loss with 18% target
Trade 3: 2% stop loss with 4% target
Trade 4: 5% stop loss with 10% target
Trade 5: 3% stop loss with 6% target
Next, I want to calculate my position size for each trade.
Trade 1: $1,000 X .03 / .04 = $750
Trade 2: $1,000 X .03 / .09 = $333
Trade 3: $1,000 X .02 = $980 (because my stop loss was lower than my risk, I just multiple the total trade portfolio allocation.)
Trade 4: $1,000 X .03 / .05 = $600
Trade 5: $1,000 X .03 / .03 = $1,000
Next, let's see how our trades did!
Trade 1: 8% profit
Trade 2: 18% profit
Trade 3: -6% loss
Trade 4: -5% loss
Trade 5: -3% loss
Let's calculate our profit...
Trade 1: $1,000 X .08 = $80 profit
Trade 2: $1,000 X .18 = $180 profit
Trade 3: $1,000 X .06 = -$60 loss
Trade 4: $1,000 X .05 = -$50 loss
Trade 5: $1,000 X .03 = -$30 loss
TOTAL = $120 Profit with a Win Ratio of 40%. (2/5 winners).
Even less than a 50% win ratio, we managed to grow our portfolio from $5,000 to $5,120.
This is why risk management is so important.
The beauty of trading crypto is the volatility we experience both in uptrends and downtrends. You can have one trade can become a 100-200 R:R trade, which will make up for hundreds of cumulative small losses if managed properly.
It's when your position sizes are too big, your stop losses are too wide and your risk rewards are less than a 1:1 ratio that you will burn your portfolio and take yourself out of the game.
CONCLUSION:
By knowing your win rate, you can increase your position sizes because your risk is lower with higher win rate %.
Your risk per trade will allow you to quickly calculate your position size.
By having a higher R:R per trade, you can remain profitable with a lower win rate %.
THANKS FOR READING! To get more of my technical analysis series, make sure you follow me to get notified!
If you don't know who I am, my name is Jacob Canfield and I'm one of the top authors on Trading View. I've been trading various markets since I was 19 years old when I bought my first options course.
After spending a decade trading in all types of markets and spending the last 3 years in the cryptocurrency markets, one thing is certain... risk management gets thrown out the window when it comes to crypto (and okay, Forex too... you know who I am talking about you margin trading degenerates)
When the terms MOON, REKT, and FOMO are the most popular phrases when trading an asset class, you know that it's doomed from the start.
Well, I'm here to change all that.
I'm introducing my FREE technical analysis series for traders and if this gets a good response... *cough cough* Go like this chart right now *cough cough*...then I will continue the series.
The BEGINNING chapter in any series should always start with understanding risk management!
I'd appreciate it if we could get this chart this trending to #1 (and you can help me do that by liking and sharing this chart) because EVERY SINGLE TRADER needs to understand these concepts, ESPECIALLY if you're new and ESPECIALLY if you're trading highly volatile markets like crypto.
I take trading very seriously and as they say in any sport, a good offense is the best defense. If WINNING trades is the offense, managing your risk is the defense.
It's more than just protecting capital, it's about STAYING IN THE GAME. Most markets have their 'peak bull runs' that last only 30-60 days out of the year.
That means, for the rest of the time you're trading, you want to manage your risk as much as possible to capitalize on those massive upswings when they do come.
Let's dig into all the terms and as we're going through... you'll get to understand how ALL these concepts work together.
ENJOY!
PORTFOLIO:
- The total value of the amount of money you’re trading with.
- Can be in Bitcoin or in USD.
- Important to always know your portfolio balance so that you can always know how to calculate your position size.
RISK PER TRADE:
- The total amount of money you’re prepared to lose.
- This is NOT your position size, just the total value that you’re risking.
- The risk per trade will help you to calculate your position size.
- The percentage of your total portfolio per trade.
- TOTAL amount you’re prepared to LOSE.
- Recommended risk per trade is 1-3% of entire portfolio.
- You can risk more if your win rate is higher.
- Smaller position sizes helps you to remain unemotional and unbiased.
- If fear and emotion enters about a trade, reduce position sizes.
Important NOTE on amount of Risk Per Trade as balances go up and down:
- If your balance is going up, then the amount goes up with it.
- If your portfolio is going down, then the amount risked goes down with it.
1-2% Is a standard risk per trade for professional traders.
1% of $1,000 = $10
1% of $5,000 = $50
1% of $10,000 = $100
1% of $100,000 = $1000
USING STOP LOSSES:
- A stop loss is a sell order that exits a trade at a certain % of risk.
- Our stop loss is the point at which our trade idea is invalidated.
- They are primarily used to manage risk in case a trade moves against you.
- A Stop Loss is a MUST if you are managing your risk appropriately.
- There are multiple strategies for setting stop losses in different and varying market conditions.
- Ideally, you want to set a stop loss below strong support structures like demand zones, moving averages, fibonacci retarcements, etc.
- I've written an entire guide on 'How To Set The Perfect Stop Loss' that you can get access to in my signature section if you want to read more about the different strategies for stop losses.
DRAW DOWNS AND RECOVERY
- We want to make sure we always use a stop loss because if you let a trade run against you, you can incur massive losses.
- These are known as draw downs and the higher % of a draw down, the higher % you need a trade to gain profit to recover.
If you lose 5% on a trade, it takes a 5.3% winning trade to get back to break even.
If you lose 10%, it takes a 11.1% winning trade to get back to break even.
If you lose 30%, it takes a 66.7% winning trade to get back to break even.
If you lose 50%, it takes a 233% winning trade to get back to break even.
If you lose 70%, it takes 400% to get back to break even.
If you lose 90% (like everyone hodling through 2018), it takes a 900% winning trade to get back to break even.
The likelihood of hitting a 5.3% winning trade is astronomically higher than hitting a 900% winning trade, which is why we take risk management so serious.
POSITION SIZING:
Divide that money amount by the price of the crypto.
This gives you your lot size to purchase to manage your risk.
Number of lots/contracts you buy or sell.
A SIMPLE CALCULATION USING BTCUSD
How do you calculate the 'lot size' after you know your dollar amount for your position size... well, that's easy.
You take the position size and divide it by the entry price of the asset you're planning on trading.
In this case, it would be Bitcoin. The current price of
BTCUSD
is $3800. So, $5,000 divided by $3800 gives you a 'contract' size of 1.315 Bitcoin for this specific trade.
ANOTHER CALCULATION USING BTCXRP (for Bitcoin Portfolio's)
In order to calculate how many XRP you should be buying, you divide 2 BTC by the price of
XRPBTC
, which is 0.00008200 sats. (satoshi's)
Compounding Effect of Losing and Winning On Your Position Size:
As you lose trades, the position sizes become smaller because the portfolio % scales down with your losses.
As you win trades, the position sizes become larger because the portfolio % scales up with your wins.
RISK/REWARD RATIO
The reward-risk ratio is equivalent to the reward (take profit) divided by the risk value(stop loss).
Usually represented by a ratio or a number.
Example: 4:1 = 4 to 1 risk reward. (or 4 R:R)
This also represents how fast winners offset losses.
It's a simple calculation:
Example:
Buying Ethereum at $100.
Your stop loss is $90 and your target is $120.
Reward/Risk = R:R ratio
$20/$10 = 2 R:R
ANOTHER EXAMPLE OF RR:
The importance of RR is that by having a higher Risk/Reward ratio value, the less number of winning trades you need to remain profitable.
What is Evolving R?
When you first enter a trade, your risk/reward is a static number that is very linear. 1:1, 2:1, 4:1 etc.
As the trade develops... either into profit or into loss, the R starts to change.
Let's say your trade moves in favor of you and your take profit is 4:1 RR, but you are currently at 2:1 RR.
Evolving R states that your NEW RR is 2:1 and your former stop loss is now a 1:2 ratio. This is where we don't want to give back profits to the market and we want to trail our stop loss or start to scale out of the position.
This is the importance of monitoring your trades as they evolve rather than taking a completely passive approach.
Evolving R is a concept derived from TraderDante I believe (a well known Forex Trader and pioneer/godfather to almost every 'price action trader on crypto twitter.)
Let's take a look at an example of evolving R.
We took a short on Bitcoin with a static RR of 5.5 and here is where the trade is at.
Now, if we evaluate our current trade position with where our stop loss is at, the evolved R as the trade has progressed is now this:
This gives us a new RR of .86 if we let the trade go all the way back to our entry zone and stop loss. This is less than a 1:1 RR on this trade.
As an active trader, we want to make sure we are constantly re-evaluating our trade set-ups to ensure proper RR as the trade evolves.
In this trade, a good strategy would be to trail your stop loss to lock in profit and maintain a strong RR as the trade moves towards our original target like this:
This gives us a continued RR of 2.41 and our stop loss is above the recent swing high in case the trade moves against us back to our original buy in zone.
Evolved R is a concept you always want to keep in mind as the worst thing to happen is miss your target by 1-2% and have it come all the way back down and hit your stop loss.
WIN RATE
Most common time frames traders measure are weekly/monthly/quarterly/annually.
Lower R:R usually requires a higher win rate to stay profitable.
A Higher R:R usually requires a lower win rate to stay profitable.
This is why knowing your win rate helps you know how much you can risk on trades.
The Risk/Reward has a correlated relationship with Win/Rate
Let's Put It All Together To Make It Simple:
I have $5,000 and I want to ONLY be in 5 active managed trades. I would allocate $1,000 to each individual trade and then I would decide on how much I want to risk per trade. Let's say it's $30 (30%).
As I was monitoring the market, I found 5 set-ups. As I find the set-up I want, I calculate my stop loss first and then I calculate my position size.
In this scenario, each trade has a 2:1 RR for the take profit target zones.
Here are 5 hypothetical sample trades that I took:
Trade 1: 4% risk with 8% target
Trade 2: 9% stop loss with 18% target
Trade 3: 2% stop loss with 4% target
Trade 4: 5% stop loss with 10% target
Trade 5: 3% stop loss with 6% target
Next, I want to calculate my position size for each trade.
Trade 1: $1,000 X .03 / .04 = $750
Trade 2: $1,000 X .03 / .09 = $333
Trade 3: $1,000 X .02 = $980 (because my stop loss was lower than my risk, I just multiple the total trade portfolio allocation.)
Trade 4: $1,000 X .03 / .05 = $600
Trade 5: $1,000 X .03 / .03 = $1,000
Next, let's see how our trades did!
Trade 1: 8% profit
Trade 2: 18% profit
Trade 3: -6% loss
Trade 4: -5% loss
Trade 5: -3% loss
Let's calculate our profit...
Trade 1: $1,000 X .08 = $80 profit
Trade 2: $1,000 X .18 = $180 profit
Trade 3: $1,000 X .06 = -$60 loss
Trade 4: $1,000 X .05 = -$50 loss
Trade 5: $1,000 X .03 = -$30 loss
TOTAL = $120 Profit with a Win Ratio of 40%. (2/5 winners).
Even less than a 50% win ratio, we managed to grow our portfolio from $5,000 to $5,120.
This is why risk management is so important.
The beauty of trading crypto is the volatility we experience both in uptrends and downtrends. You can have one trade can become a 100-200 R:R trade, which will make up for hundreds of cumulative small losses if managed properly.
It's when your position sizes are too big, your stop losses are too wide and your risk rewards are less than a 1:1 ratio that you will burn your portfolio and take yourself out of the game.
CONCLUSION:
Your risk per trade will allow you to quickly calculate your position size.
By having a higher R:R per trade, you can remain profitable with a lower win rate %.
THANKS FOR READING! To get more of my technical analysis series, make sure you follow me to get notified!
Related Ideas
#2 in the world... Almost got to #1.
I hope a lot of people found this educational post helpful.
A few notes...
I wrote this at 1am, so I didn't double check my math on some things and the 'publish' feature leaves some room to be desired as far as going through and checking your work. Also, there is no 'edit' button after it's published.
I wrote this so that a beginner trader could read it and understand it. I intentionally left out specific phrases and terminology and kept it basic so that ANYONE could learn from it.
If you're an advanced trader, you should already know this information.
The formula's I used are the easier ones to use for beginner traders, but there are more advanced formulas that you can use.
For instance, in the comments, someone pointed out my position size and my risk to reward formula's could be improved upon, so I wanted to just post them here as well:
1) Position size calculation formula should be: (account*risk per trade)/(sl distance*tick value). Here: account is the account balance or account equity (you choose); risk per trade is the amount of money you want to lose if sl hit; sl distance is the distance between entry and sl calculated using the folrmula ABS(entry-sl); tickvalue is the amount of money one loses/gains if trading standard contract and price moves one tick.
2) Risk to reward ratio formula: ABS(enty-sl)/ABS(entry-tp).
I wanted to make a few corrections as were pointed out in the comments.
DRAW DOWNS AND RECOVERY SHOULD BE:
90% 11%
80% 25%
70% 43%
60% 67%
50% 100%
40% 150%
30% 233%
20% 400%
10% 900%
Let me know in the comments what you guys want to learn more about when it comes to trading...
If you haven't already, I also did a video break down of these topics that you can get access to for free by clicking the link in my signature below.