Risk Management: Satefy Orders (Dollar Cost Average)I believe risk management is key, because sometimes, finding the perfect entry will not be enough.
The market is what it is, and nobody can predict with 100% accuracy how the price will behave, even with all the great indicators we got out there.
With that in mind, we should come prepared that the price will go against you, and we should take advantage of it, because most of the time it will bounce back up.
This technique is especially useful in trading low timeframe also known as Scalping.
The idea is to lower the inital entry order size , and split the remaining order size progressively through the safety orders as the price goes against you. This will make the total trade average entry - or break even - at a lower place than if you were simply trading the initial entry.
That means the take profit will also be lower, because we can now take profit from the total order size/volume .
Here is a simple example with a long:
We buy in on the `LONG` label with 10% of our trade capital at around 9325$. Our take profit is 1.3% which makes a 9447$ target.
But the price goes down, until it reaches our first safety order trigger line, at around 9231$.
At this point we add 10% of our trade capital. It is the `DCA` label on chart. The break even line is now in the middle of the inital entry price and the safety order price, around 9275$. We still have our 1.3% take profit target, but it is now at 9396$ instead of 9325$.
At last, the price bounces back up, as expected, and we take profit.
Example with a short with 2 satefy orders:
What are the risks?
In the worst case scenario , which we know will happen at some point, the price does not go back up.
It is important to know what are the risks so that we do no get liquidated or lose too much of our account.
Let's dive into the numbers.
We set up our strategy so that we have 3 satefy orders max, and the stop loss is on step below the last one.
That makes 4 entries in total, and we decide to use 1% of our capital on each entry.
Each step is seperated by 1% of the price to make things easier.
When we hit stop loss, how many % do we lose?
1. On first safety order, price is down 1% and we traded 1%. That's 1% drawdown.
2. On second safety order, price is now down 2% for 1% of our order, and 1% for the other 1%. That is 1.5% drawdown.
3. Of the third safety order, we get 3% + 2 % + 1% = 6%/3 = 2% drawdown.
4. On stop loss, we get 4% + 3% + 2% + 1% = 10%/4 = 2.5% drawdown.
=> The price went down 4% but we only lost 2.5% of our inital capital. That is why we can say that safety orders reduce risk .
/!\ Using leverage will multiply the risk. Using 2x we would have lost 5%. This can climb very fast, so be careful.
One thing we can do when a stop loss is hit is to reverse our order, as most of the time our stop loss is hit because the trend is reversing. But again, be careful as it could cost you double.
