Money management and risk management are a very important part of trading. To be a successful trader, you need to master the three most important parts (technical analysis, psychology and money management). But what do you actually imagine under that?
Money management and risk management for everyone
It may be an unknown or relatively difficult concept to imagine, but in reality it is very simple. Money management is a rule that governs your finances when trading. How much money (or% of your portfolio) you put into each trade. How much will you start trading with. And many other issues related to the finances you trade and how you use them.
Risk management, on the other hand, talks about how to set a stop loss. Do you want to risk a very narrow stop loss to have the highest possible RRR (risk to reward ratio), or would you rather give a larger stop loss? With risk management, it is undoubtedly true that you have to enter a stop loss for each trade and exactly according to your strategy. It’s a strong discipline that can be very emotional, but in many cases it can save you, so you have to “act like a machine” and follow a strategy.
What is RRR and how to use it?
Risk to reward ratio (often referred to as risk / reward ratio) is a tool to help you determine the value of what you are risking versus the value of what you can earn in a given trade. RRR 1: 1 tells you that in order to get one unit (dollar, BTC, satoshi), you risk one unit (dollar, satoshi, BTC).
On tradingview you can find this tool called long position (in case of long position) or short position (in case of short position). When using a given tool, you will see a ratio (RRR), which will tell you how you are doing in a given trade with your target and stop loss.
In order to find out which RRR is right for you, you need to know what type of trader you want to be. In each case, the ratios and the RRR are different. When scalping, 1: 1 to 1.5: 1 is recommended (but scalping is not recommended for beginners). When trading day, you should have an RRR of at least 2: 1. In short term trading, the RRR should be between 3: 1 and 5: 1 and swing trading should be at least higher than 5: 1.
Two rules that can change your trading
In money management, it is necessary to know how much you want to put into which business and how much you are willing to take risks. It is generally recommended to invest max. 10% of your portfolio in one trade. Also, in every trade you need to have a stop loss, which should not exceed 10% (which means that you risk 1% of your entire capital).
The second piece of advice is – before you want to start trading, take a back test of your strategy, money and risk management. It is not a bad idea at all to try to have the same RRR. This can best show you what results your strategy really delivers.
Conclusion on money management
Proper money management and risk management may seem very simple at first, but believe me, it’s quite challenging – especially on the psyche of the trader. It is good to realize that these are the small details that can ultimately make a significant difference between profitable and loss-making traders.