Stock Market

The myth of risk management – Hack it :) for BITSTAMP:BTCUSD by Exactus

I speak to a lot of traders, new and veteran.

It’s surprising to see how so many are not sure how risk is calculated and what the exposure really means in terms of P&L.

This obviously is a major block in the road on the way to gaining confidence necessary to avoid losses.

So let’s break it down –

*P&L is calculated by lot size * movement.

Example: If you have 100 ounces of Gold (1 lot) – That’s $100 in P&L (Profit/loss) for each $1 Gold moves in value, so if the price 1890 and you are buying 1 lot , price moves by $5 higher – That’s a $500 profit ($100*$) , same thing in reverse, if it would drop by $5 that’s a negative of -$500 in open P&L.

Leverage decides what you are technically able to open in terms of margin used.

So if your leverage on Gold is 1:100 – The value of a 1 lot trade is the price of Gold multiplied by the amount of ounces , so let’s say 1890*100 = $189,000 value trade, but your leverage is 1:100, so you would only need $1,890 of used margin (189,000:100) to open the trade.

But if you have 1:20 as leverage, you would need 5 times more used margin to open the trade.

So a common misconception is that your risk is your leverage.

That’s not true.

Your risk is your lot size.

But if you have very high leverage , than you can open very high lot size with a small account – Which is extremely dangerous and not advised.

So what does an experienced , smart trader do? No matter what his leverage is, he understands the short-term and the long-term range of movement, and opens a lot size that fits the size of his account considering the range of movement.

If the account size is $100,000 , and you are buying 1 lot of Gold:

The weekly range is 1840-2,000 , the short-term range is 1880-1910 – Price is 1890

So the exposure is ~$1,000 in the short-term (1%) back to the short-term support 1880 , compared to $2,000 on the short-term resistance (2%) of 1910.

The long-term exposure is to 1840, meaning a $5,000 exposure 5% ($100*$50) from 1890 – but 2,000 is the top of the weekly range, meaning – $110 up ($110*100) = $11,000 (11%).

So didn’t really matter what the leverage is 1:20 or 1:100, what matters here is the range and the lot size.

Thank you for reading!


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