3 Easy Steps to Proper Risk Management for Margin Traders

By TheBirbNest

This guide is sponsored by Prime XBT, the leading Bitcoin-based margin trading platform. All links to Prime XBT in this guide are referral links.

Have you ever wished you had more money to trade with?

With margin trading, you are able to trade as if you had much more money than you have on your account. For example, on Prime XBT, you can trade with up to 1000x leverage. This means that using just a $100 deposit, you could be trading as if you had $100,000.

Leveraged trading allows you to trade with more capital than you deposited into your account

“Great,” you may be thinking. “Now I can make several times more money!”

This is true. However, as all traders should always remember, there is no reward without risk.

Margin trading amplifies the profits you would make on your trade, but it also increases the amount of money you would lose if the trade does not go in your direction. It is a very powerful tool, but if you do not know how to use it properly, you can end up hurting yourself.

In this guide, we will outline three easy steps you can implement today to ensure you are using leveraged trading with proper risk management.

Step 1: Determine Your Risk Per Trade

The beginning trader often places overly large trades in hopes of making big profits. This is great if you win, but few traders consider what happens when they inevitably lose a trade.

If no stop loss is used, then it is possible to blow up your entire account with a single bad leveraged trade. 

But let’s say you were smart enough to place a stop loss. The question then becomes, how much of your capital should you put at risk every time your stop loss is hit?

At The Birb Nest Trading Community, we recommend that all our exclusive members follow the risk management rule of 2% risk per trade or less. Simply put, once you have determined your stop loss (based on technical analysis or your trading system), the amount of money you put into the trade should be adjusted so that only 2% of your capital is lost if your stop loss is hit.

For example, if you were trading with 1 BTC of capital, then 2% risk would mean adjusting the size of your trade so that you only lose 0.02 BTC when your stop loss is triggered.

Why do we use 2% and not 10% or 20% risk per trade? 

While 20% risk per trade may give you more profit, you could also easily lose all your money in just a few bad trades.

Suppose you start out trading with $10,000 USD. Using 20% risk per trade, after only 5 losing trades in a row, you would be left with just $3276.8 and be forced to more than triple your money in order to break even. If you had instead used 2% risk per trade, 5 losing trades in a row would have left you with $9039 USD, a small loss that would be much easier to bounce back from.

The goal of the 2% risk per trade rule is to leave yourself with a healthy amount of capital in your account even after several losses in a row, making it easier for you to claw your way back into profitability.

Note that it is not always necessary to risk 2%. If you are scalping, learning, or taking a trade that you think is riskier than usual, you may want to go even lower down to 0.5–1% risk per trade.

The following video from the Nest Club member’s video library explains the 2% risk per trade rule in more detail:

The 2% Risk Per Trade Risk Management Strategy can help you keep your losses in check

Step 2: Filter Your Trades Using Risk/Reward Ratio

Once you have determined how much money you are willing to risk, the next step is to filter your trades using the risk/reward ratio.

Every trade you enter involves putting some capital at risk in exchange for a potential reward. Using technical analysis or your chosen trading system, you can determine exactly where your stop loss and take profit levels will be for a certain trade. This allows you to figure out exactly how much money you could win in each trade for every dollar you put at risk, or the risk/reward ratio.

For example, if you had a trade where your stop loss would lose you $20, but your take profit target would get you $80, then your risk/reward ratio for that trade would be 4:1.

Another number you need before you can make full use of the risk/reward ratio is your average win rate. Through journaling or backtesting, you should be able to find your average win rate with a particular trading strategy. Based on this win rate, you will want to only enter trades that have a certain risk/reward ratio or better. 

The chart below illustrates the profitable risk/reward ratios over time for trading strategies with a win rate from 20-60%. The lower your win rate, the higher the risk/reward ratio has to be in order for you to stay profitable over time.

The lower your win rate, the higher the risk/reward ratio must be for you to stay profitable

By filtering your margin trades and only taking those that have a risk/reward ratio that suit your personal performance with a particular trading strategy, you will tip the odds in your favor, making it far more likely that you will be profitable in the long run.

Step 3: Determine Your Position Size

Armed with your risk per trade and a good setup with a suitable risk/reward ratio, you are now ready to calculate how much capital you should put into the trade.

Most margin trading exchanges should have a trading tool that allows you to input all the details of your trade and calculate how much you would make or lose based on your entry, stop loss, and position size.

After putting your entry and stop loss into your exchange’s calculator tool, adjust the amount you are putting into the trade (position size) so that the amount you would lose when your stop loss is hit matches the number determined by your 2% risk per trade calculation.

For example, let’s say you are trading with 1 BTC of capital, which means you have a risk per trade of 0.02BTC. Your technical analysis has given you a long setup for Bitcoin, with an entry at $9000 and a stop loss at $8750.

Let’s see how we can calculate the proper position size for this trade if we were to place it on a real margin trading exchange like Prime XBT.

On Prime XBT, there is no need to open a separate calculator before entering your trade, as the calculations can be made right within the order window. Since they use cross leverage, there is also no need to manually decide how much leverage we want to use for this order. We simply input the desired entry price into the Limit Price (A) along with the predetermined Stop Loss Price (B). 

Notice the Projected Loss (C) number. This is how much you would lose if the stop loss is hit. Right now it is at 0.00026820 BTC. We want this number to be at our 2% risk per trade amount of 0.02 BTC. To get this number closer to our target number, we must adjust the Amount (D).

After some trial and error, we find that the Amount (A) that would get us closest to our target of 0.02 BTC Projected Loss (B) without going over  is 0.74 BTC.

Since Prime XBT offers 100x leverage for crypto trading, the Margin Impact (C), or the amount of BTC we need in our account to open this trade, is only 0.00744011 BTC.

At this point, as a margin trader, you should also consider the liquidation price, or the price at which your position will be forced to close due to a lack of funds. If your liquidation price would be reached before your stop loss, then you will need to reconsider the parameters of your trade.

For exchanges using isolated margin, you can adjust your trade or leverage to make sure your stop loss is hit before your liquidation level.

In the case of Prime XBT, cross leverage is used, so you must ensure that you have more than the Projected Loss  of 0.01988750 BTC ready in your Available Margin to avoid getting liquidated before stop loss is hit. Bear in mind that if you open multiple trades, your Available Balance needs to be enough to cover the losses from every single trade.

We are now ready to place our trade.

Conclusion

With the proper precautions, margin trading can be a very powerful tool that allows you to trade as if you had much more capital than you deposited into the exchange. 

While the recommended 2% risk per trade rule will not allow you to place all that capital into one trade, the leverage does allow you to free up more capital to open more trades (just make sure . This is especially useful on an exchange like Prime XBT where you can find trading opportunities across many different, potentially uncorrelated assets like cryptocurrencies, forex pairs, commodities, and indices.

To get started trading all these assets using Bitcoin with up to 1000x leverage and no KYC, visit www.thebirbnest.com/primexbt.