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Henry Lin
Henry Lin

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Lesson 14: Risk Management

#beginners #tutorial #crypto #security

Lesson 14: Risk Management

⏱ Duration: 2 hours
🎯 Learning Objectives: Master comprehensive risk management principles and practices

Course Overview

Risk management is the most critical component of successful trading. Even the best strategy will fail without proper risk controls. This lesson covers essential risk management principles and how to implement them in Freqtrade.

Why Risk Management Matters:

  • ✅ Protects your capital from catastrophic losses
  • ✅ Ensures long-term survival in trading
  • ✅ Reduces emotional decision-making
  • ✅ Provides systematic approach to position sizing

Core Risk Management Principles:

  1. Capital Protection First - Never risk more than you can afford to lose
  2. Systematic Approach - Use predefined rules, not emotions
  3. Diversification - Spread risk across multiple positions/pairs
  4. Continuous Monitoring - Regular review and adjustment

14.1 Types of Trading Risk

Market Risk

  • Price volatility - Unexpected market movements
  • Gap risk - Sudden price jumps over your stop loss
  • Liquidity risk - Unable to exit positions at desired price

System Risk

  • Exchange issues - API failures, maintenance
  • Network connectivity - Internet disruptions
  • Software bugs - Strategy execution errors

Psychological Risk

  • Emotional trading - Fear and greed driving decisions
  • Overtrading - Excessive trading activity
  • Revenge trading - Trying to recover losses quickly

14.2 Risk Management Tools in Freqtrade

Stop Loss Configuration 

# Fixed stop loss
stoploss = -0.10  # 10% stop loss

# Dynamic stop loss (trailing)
trailing_stop = True
trailing_stop_positive = 0.01
trailing_stop_positive_offset = 0.015
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Position Sizing 

{
  "stake_amount": "unlimited",  // or fixed amount like 100
  "max_open_trades": 5,         // Maximum concurrent positions
  "tradable_balance_ratio": 0.99 // Use 99% of available balance
}
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Time-based Exits 

{
  "unfilledtimeout": {
    "entry": 10,    // Cancel entry after 10 minutes
    "exit": 10      // Cancel exit after 10 minutes
  }
}
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14.3 Risk Management Strategies

1% Rule

Never risk more than 1% of your total capital on a single trade:

# Example calculation
total_capital = 10000  # USDT
max_risk_per_trade = total_capital * 0.01  # 100 USDT
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Position Sizing Formula 

def calculate_position_size(account_balance, risk_percent, stop_loss_percent):
    risk_amount = account_balance * risk_percent
    position_size = risk_amount / abs(stop_loss_percent)
    return position_size

# Usage
account_balance = 10000
risk_percent = 0.01  # 1%
stop_loss_percent = 0.05  # 5% stop loss
position_size = calculate_position_size(account_balance, risk_percent, stop_loss_percent)
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Portfolio Risk Management 

{
  "max_open_trades": 3,
  "stake_amount": 0.3,  // 30% of capital per position
  "max_drawdown": 0.15   // Stop trading if 15% drawdown
}
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14.4 Advanced Risk Management

Correlation Management

Avoid overexposure to correlated assets:

# Check correlation before opening new positions
def check_correlation(existing_positions, new_pair, threshold=0.7):
    # Implement correlation checking logic
    pass
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Volatility-based Position Sizing

Adjust position sizes based on market volatility:

def adjust_for_volatility(base_position, current_volatility, avg_volatility):
    volatility_ratio = current_volatility / avg_volatility
    adjusted_position = base_position / volatility_ratio
    return adjusted_position
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Drawdown Control 

def check_drawdown(current_balance, peak_balance, max_drawdown=0.20):
    drawdown = (peak_balance - current_balance) / peak_balance
    return drawdown < max_drawdown
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14.5 Risk Monitoring and Alerts

Daily Risk Check 

# Daily risk assessment checklist
def daily_risk_check():
    check_account_balance()
    review_open_positions()
    verify_stop_losses()
    assess_market_conditions()
    check_system_health()
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Alert Configuration 

{
  "telegram": {
    "enabled": true,
    "chat_id": "your_chat_id",
    "token": "your_bot_token"
  },
  "api_server": {
    "enabled": true,
    "listen_ip_address": "127.0.0.1",
    "listen_port": 8080
  }
}
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🎯 Practical Tasks

Task 1: Risk Assessment

Analyze your current strategy:

  • Calculate maximum historical drawdown
  • Determine position sizing rules
  • Set appropriate stop losses

Task 2: Risk Management Implementation

Implement comprehensive risk controls:

  • Set maximum position sizes
  • Configure stop losses
  • Set up monitoring alerts

Task 3: Risk Testing

Test your risk management with different scenarios:

  • Market crash simulation
  • Extended drawdown periods
  • Multiple consecutive losses

📚 Key Risk Management Rules

  1. Never risk more than 1-2% per trade
  2. Always use stop losses
  3. Diversify across different assets
  4. Monitor positions regularly
  5. Have a maximum daily/weekly loss limit
  6. Keep emotions out of trading decisions
  7. Regular review and adjustment of risk parameters

⚠️ Critical Risk Management Warning

No risk management system can prevent all losses, but it can prevent catastrophic losses that end your trading career.

Remember: The goal is not to eliminate risk entirely (which is impossible), but to manage it effectively and ensure long-term survival in the markets.

Proper risk management is what separates professional traders from gamblers.

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