Do you know how to manage your crypto trading risk?
“The revolutionary idea that defines the boundary between modern times and the past is the mastery of risk:
the notion that the future is more than a whim of the gods and that men and women are not passive before nature.
Until human beings discovered a way across that boundary, the future was a mirror of the past
or the murky domain of oracles and soothsayers who held a monopoly over knowledge of anticipated events.”
Every day, multiple times a day, the anonymous oracles and soothsayers of the Internet make predictions and assertions about where cryptocurrencies will go.
They will go higher.
They will go lower.
They will become the defacto standard…
Have you made any money trading on these predictions?
Human beings are notoriously bad at making long term predictions especially in dynamic environments like markets. So do you really want to risk your hard earned money relying on the predictions of the oracles of the Internet?
These soothsayers are not the only adversaries you have in the market. There is another adversary that you need to manage to keep and grow your wealth no matter what markets you trade in.
Who is this adversary?
Your biggest adversary trading in cryptocurrency markets is you.
Are emotions bad for trading? Maybe not
Trading brings out strong emotional reactions in most people when they start out. There is excitement when you open your account and put on that first trade. There is anticipation. Elation as your buy goes higher, fear and doubt as your position goes lower.
On the Internet you will be told to ignore these emotions, they will hurt your results. You need to be “rational,” they tell you.
How are you supposed to do that?
What if emotions are a key piece of information to be experienced and observed?
What if emotional responses are the reason why you should have a series of trading principles or rules to help you manage the risks of trading?
A trader without trading rules is a slave to his or her emotions, and the problem with this approach is that you learn little while paying the endless tuition of losses.
All trading decisions are emotional
As Jim Camp points out in his book: Start with No, all decisions are emotional. Every single one. So it will follow that trading decisions will have an emotional component. The question is what do you do about that?
What you should be considering is how to develop a series of principles or trading rules to help you manage your trading risks, one of which is your emotional responses.
In the cryptocurrency market, for example, you have a series of risks. There is market risk driven by rumours and the way the system works, event risk based on news from around the world, execution risk meaning paying to much or receiving too little, and regulatory risk.
You have no control over most of these, but you do have control over your biggest adversary in the market, the one that will cost you the most, and that is the way you perceive your emotional reactions to events.
Risk management starts before the trade
Imagine you set up your account on an exchange such as Bitvo. You transfer some money into the account, and you’ve decided you want to buy some BTC.
What are you feeling right now as you do this?
Well, you might be a bit anxious if this is the first time you are putting on a trade.
You might feel a rush of excitement.
What are you going to feel like if it goes lower? What about higher?
How are you going to make decisions going forward once you have a position?
Are you going to rely on the Internet oracles and soothsayers or will you be taking agency for your position?
Trading starts before the trade is put on. It starts with some thinking and planning. It is this thinking and planning that will help you use your emotions as information and guidance and allow you to manage your trading risk.
No trading rules? Start here
Every great trader has a set of rules and principles that they developed over time with experience. The traders that came up in the old way, with a mentor, used the rules their mentor used until they developed their own trading style and experience. The trading rules were a set of principles designed to help them manage their trading risks.
Managing trading risks means keeping your losses to a manageable level so you can come back and trade another day. It means keeping those losses from becoming so big that you are frozen with fear and doubt and unable to make necessary decisions for self-preservation. It also means knowing how and when you will monetize your gains if your trade works out.
Risk management is also a tool for accelerating your learning and trading development.
So how do you do this without a lot of experience?
Start with some important questions.
Risk management starts with a personal question
The single most important question to ask yourself before starting to trade is this: what is the underlying reason for trading in the first place?
This seems like an easy one. You want to make money right? Or become wealthy or something like that. Now go a layer deeper.
Is it because you want to be seen as smart? Or have something to talk about in polite company? Or maybe you like gaming, and you see it as a game. Perhaps you think it will help you understand crypto by participating. It could also be a vote against the system, a protest. Maybe you are simply looking for some excitement.
Don’t skip this step.
It seems superficial at first, but once you are completely honest with yourself, you can understand your decisions, the emotional triggers and plan your path accordingly.
The market is ruthless in uncovering your deepest fears and insecurities about money. So by acknowledging them up front, you are on the path to self-mastery, meaning you are not guided exclusively by emotional decision-making.
Ok, so you know why you are getting involved, what’s next?
What are you going to trade? Are you going to trade it because you heard about it from a friend, or on social media? Or maybe you read some articles and want to get involved.
Write this reason down. It will come in handy later.
What is your entry price?
Now what price are you thinking about entering the trade, and how will you determine what that entry point will be?
Will you be entering your position all at once or will you scale lower or higher?
Will you enter a bid with a limit price or will you buy the offer? Either way, consider using a “limit” order especially in markets like these. That means an order with a specified price as opposed to a “market” order.
There is a term called “slippage” which is the amount it costs you to enter or exit a trade when you buy or sell from the bid-ask spread. By paying the offer or selling the bid, the more slippage you experience and the worse your returns. When the difference between the bid and offer (the “spread”) is wide, slippage is bigger than when the spread is small.
What time period will you enter the order? Will you try to take advantage of illiquid conditions during specific time periods with “stink” bids and offers (that are off the bid-ask spread) or will you enter during periods with higher liquidity and market activity?
How do you figure this out? Technical analysis is a pretty good tool to help you make your decision. Then there are market stats and volume metrics from different time zones around the world.
Once you figure this out, write down the strategy for your entry point, the time and the reason.
How much pain will you accept?
Next, you should be deciding where your tap out point is.
This is a critical part of risk management. Deciding in advance where you will sell or lighten up to preserve your capital means staying solvent. If you lose all your money, you can’t come back tomorrow. And the psychological pain of losses and no idea what to do can freeze you into indecision, making things infinitely worse.
So start by planning out your financial pain threshold which is your tap out point. This can take into account the known daily or weekly volatility range of the asset you are trading, so you don’t get stopped out with normal market gyrations.
Once you’ve decided what your acceptable drawdown will be, maybe a certain percent from your entry point, then decide what you will do there, sell it all or lighten up a bit.
Write these numbers down and the reason for them.
If you are faced with a situation where you are frozen and struggling to make a decision to hold or fold, sell a small portion of your position to help free up your mind. That one tiny sell, planned as a safeguard, can unlock indecision and get you back on track.
But in the meantime, you can also refer to the plan you wrote out in advance.
Winners require an exit strategy too
Next, what are you going to do as your trading hypothesis unfolds as anticipated?
Let’s say you buy 1 BTC at $7700 CDN. You think based on your analysis that it will be going to $10 000 CDN.
Why this price? Is there a resistance point on the chart? Heard a rumour? Maybe you are making a guess. Whatever this number is, write it down and write down the reasoning.
Next, if you trade unfolds as expected, how will you exit your trade, or will you?
For example, you can decide that at your target you will sell half of your position to lock in some gains and let the other half ride. Or you might decide to start scaling out 25% at a time at predetermined price points if it continues to progress.
Write this decision down and revisit it if your plan unfolds as anticipated.
Next, timeframe. How long do you think this will take? The timeframe is key, because if you think this will take a couple of months, then you don’t need to watch the ticker all day. If it’s happening any day, that requires different focus and attention.
Your pre-trade outline
So far you have a rough plan laid out including:
- > Reason for being involved.
- > The cryptocurrency you will be trading
- > Entry point price and time
- > The way the entry will be executed (one or more transactions)
- > Your tap out point or maximum drawdown (a specific price or percent of trade amount)
- > What you will do when the tap out point is reached
- > Your price expectation for the upside
- > What you will do when the upside price is reached (sell, scale, part out, hold and move stop)
How much for each trade?
How about how much of your capital you will use to enter the position?
There are several ways to decide how much to use, but first and foremost it’s time to revisit the first question: what is the real reason you are getting involved?
And next, it’s important to recognize that crypto is one asset class in a universe of asset classes, so putting all your resources in one asset class is not a good risk management strategy. This decision is a bit tougher if you have a small amount of capital.
Now keep in mind that crypto for all its promise is a largely unregulated, speculative asset. That doesn’t mean it won’t succeed or that it will, but what it should tell you is that using all of your capital on this one asset is probably not an ideal strategy.
So take your resources and start with a small portion. As your capital grows, you should only use a small percentage for each trade idea. So if you have $10 000, you might decide to use 10% or 15% max.
Whatever the amount will be, write it down.
Your trading diary
After writing all of these things down, what you have in your hands is a trading diary. You have the thinking, the strategy and the reasons behind it. This process is the foundation for your risk management, and it is also going to help you in two very significant ways.
First, you are going to accelerate your learning curve. By keeping a record of why you entered a trade, executed it, and closed it out, you will see what you are doing well and what you aren’t doing well. With each new trade, you will adapt and hone these notes, and the result will be a set of trading rules and principles of your own.
By managing your entry and exits, you will be adding discipline to your trading process which will preserve your capital and eventually help it grow.
Now the second result of this gets back to our old so-called nemesis: emotion.
Your emotions won’t disappear because of writing down your trading plan, but what will happen is that they will have a smaller influence. With the thinking is done in advance in a low-pressure environment, your plan will be unemotional. The execution of your plan will have all the emotions present, but the plan will guide you regardless of how you “feel” while you do it.
The market is ruthless when it comes to our money emotions and deficiencies. The trading plan is designed to help you work around those.
Over time you will be able to see the emotional reaction for the information that it is. It will move from the self-talk of: I’m afraid, I’m excited, I feel ill – to: why do I feel this way? What is going on? What does this mean? What should I be doing based on this information?
Then you will take that information and use it to override your hard-wired emotional expression.
Risk management is the key to successful traders and a thriving ecosystem
All markets have risk, some more than others. Unregulated, speculative products that trade seamlessly across many regulatory, national and legal boundaries are in a league all their own.
It is participants like you that will help with the development of cryptocurrencies through trading and exchange. As an exchange, Bitvo is designed to bridge the gap between the legacy financial system, and the one of the future helping you develop your trading acumen. But Bitvo and the cryptocurrency movement benefit only if you are successful long-term.
And that means ignoring the predictions of the anonymous soothsayers and oracles of the Internet and taking charge of your trading process and risk management. The more agency you take over your trading behaviour and results, the faster you will accelerate your learning process.
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