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Lesson 7 of 8

Risk Management & Trading Psychology

Risk management is arguably the most important skill in trading. Without it, even the best strategy will fail. In this lesson, you'll learn how to protect your capital and master the psychological aspects of trading.

Why Risk Management Matters

Many traders focus on finding the perfect entry, but surviving long enough to profit is more important. Consider this: if you lose 50% of your capital, you need to gain 100% just to break even.

Loss	Gain Needed to Recover
10%	11%
25%	33%
50%	100%
75%	300%
90%	900%

⚠️ The Math of Ruin

A 50% loss requires a 100% gain to recover. This is why protecting capital is more important than maximizing gains. Small, consistent losses are manageable. Large losses can end your trading career.

Position Sizing

Position sizing determines how much capital to allocate to each trade. This is the most powerful risk management tool.

The 1-2% Rule

Never risk more than 1-2% of your total capital on a single trade. This means if your stop-loss is hit, you lose only 1-2% of your portfolio.

💡 Position Size Calculation

Example:
Account: $10,000
Risk per trade: 1% = $100
Entry: $50,000 (BTC)
Stop-loss: $49,000 (2% below entry)

Risk per coin: $50,000 - $49,000 = $1,000
Position size: $100 ÷ $1,000 = 0.1 BTC
Position value: 0.1 × $50,000 = $5,000

Position Size Formula

Position Size = (Account × Risk %) ÷ (Entry - Stop Loss)

This ensures your loss is capped regardless of how wide your stop is.

Stop-Loss Strategies

A stop-loss is a predetermined exit point if the trade goes against you. Always know your stop before entering a trade.

Types of Stop-Losses

Fixed Stop

Set percentage below entry (e.g., always 3% below). Simple but doesn't consider market structure.

Technical Stop

Placed below support levels, trendlines, or moving averages. Adapts to market structure.

Volatility Stop

Based on ATR (Average True Range). Wider in volatile markets, tighter in calm markets.

Trailing Stop

Moves with price to lock in profits. Exits when price retraces by set amount.

Stop-Loss Best Practices

Place stops at levels where your thesis is invalidated
Don't place stops at obvious round numbers (easily hunted)
Give trades room to breathe - too tight = stopped out on noise
Never move stops further away - that's adding to a loser
Use mental stops only if you have extreme discipline

Risk-Reward Ratio

The risk-reward ratio (R:R) compares potential profit to potential loss. A good R:R means you can be wrong more often than right and still profit.

Calculating Risk-Reward

R:R = (Target - Entry) ÷ (Entry - Stop Loss)

💡 Example

Entry: $50,000
Stop Loss: $48,000 (Risk: $2,000)
Target: $56,000 (Reward: $6,000)

R:R = $6,000 ÷ $2,000 = 3:1

With 3:1 R:R, you only need to win 25% of trades to break even!

Risk:Reward	Win Rate Needed to Break Even
1:1	50%
1:2	33%
1:3	25%
1:5	17%

Most professional traders aim for minimum 2:1 R:R. This gives room for error while remaining profitable over time.

Portfolio Risk Management

Beyond individual trades, manage risk across your entire portfolio.

Key Rules

Maximum portfolio risk: Never risk more than 5-6% of total portfolio at once
Correlation awareness: Multiple crypto trades are often correlated - if BTC drops, most alts drop
Diversification: Don't put everything in one coin or one sector
Cash is a position: Being in cash during uncertain times is valid
Scale positions: Start small, add to winners, not losers

⚠️ Correlated Risk

If you have 5 altcoin positions at 2% risk each, your actual risk might be 10% because they all correlate with Bitcoin. When BTC drops, they all drop.

Trading Psychology

Your mindset is as important as your strategy. Most trading failures are psychological, not analytical.

Common Psychological Pitfalls

FOMO (Fear of Missing Out)

Chasing pumps, entering late without analysis. Usually results in buying tops.

Revenge Trading

Trying to immediately recover losses by taking bigger, riskier trades.

Overconfidence

After wins, taking larger positions or ignoring rules. "I can't lose."

Loss Aversion

Holding losers too long hoping they recover, cutting winners too early.

Confirmation Bias

Only seeking information that supports your position, ignoring warning signs.

Analysis Paralysis

Over-analyzing to the point of never taking action or missing opportunities.

Building Mental Discipline

Successful trading requires emotional control. Here's how to build it:

1. Create a Trading Plan

Define your rules BEFORE you trade:

What setups you trade
Entry and exit criteria
Position sizing rules
Maximum daily/weekly loss limits
When to take breaks

2. Keep a Trading Journal

Record every trade with:

Entry/exit prices and reasoning
What you were thinking/feeling
What went right/wrong
Screenshots of the setup
Lessons learned

3. Accept Losses as Part of Trading

No strategy wins 100% of the time. Losing trades are not failures - they're part of the business. Focus on execution, not individual outcomes.

4. Take Breaks

Step away after big wins (overconfidence risk)
Step away after big losses (revenge trading risk)
Don't trade when tired, emotional, or distracted
Crypto runs 24/7 - you don't have to

✓ The Professional Mindset

Think in probabilities, not certainties. Your edge plays out over many trades, not one. Execute your plan consistently. Review and improve. Treat trading as a business, not gambling.

📋 Lesson Summary

Protecting capital is more important than maximizing gains - losses compound
Never risk more than 1-2% of your capital on a single trade
Position size = (Account × Risk %) ÷ (Entry - Stop Loss)
Aim for minimum 2:1 risk-reward ratio on every trade
Manage portfolio-level risk, especially correlated positions
Common psychological pitfalls: FOMO, revenge trading, overconfidence, loss aversion
Build discipline through trading plans, journals, and accepting losses as part of the game