Many people still don’t understand why would they need risk-management, coming from the place of not yet having to deal with the possible consequences. Here is a story of a Reddit user where he shares how not to trade and what it may lead to.
How I Lost Nearly 200 BTC trading this past month
Long story short, I started trading a year ago and have been margin longing the whole run from 1k to 19k (sometimes closing the top, at times too early or too late, but always making profit)
I turned 3 humble btc that I had from playing poker (3k at the time) into nearly 200 BTC that was almost 4 million at its best price and would be 2 million right now. I thought I was a trading genius, a god, whatever. Anyway, this is where the sadness began. After 19k plummeted to 11k I spent a lot of time at the bottom, slowly adding to my position on the bounce to 12k 13k, 14k. Then, during the dead cat bounce at 16k, my position was a further 100 BTC in profit. Instead of closing right away and having a total of 300 BTC, I increased leverage and bettered my position. But because my entry had moved up so much, everything got liquidated on the drop back to 12k. I lost 100 btc of paper profit and nearly 50 BTC margins. I was devastated and down to 150 BTC total.
Having evaluated the situation, I came to the conclusion that the jump to 16k was a dead cat and we were going down. Therefore I shorted. At 12k. Added at 13k. Added at 14 and 15k. Got liquidated at the top with 17k. Another 50 BTC loss. Down to a 100.
Think, ok we pushed the ceiling at 17k, back on uptrend. Times fly by, whe get liquidated at 13k.
50 BTC left. Devastated, unsure, no clue what’s going on. Went through the drop to 9k, when we bounced I thought it could be the bottom. Longed at 11500, panic closed at 10500. When we went to 13k I was hating myself for panic closing, went long at 12800.
And boom, liquidated this morning for my last bitcoin.
3 BTC to 200, to 0
At this time I am still in shock, the last few months I’ve neglected relationships and school, and I’ve been daydreaming about living the high quality life being rich as fuck with my millions.
Now, I am nowhere.
First, you got to answer this simple question: are you a trader or a player? Cryptocurrencies open a variety of great gambling opportunities, however you’ll be dependant on your luck and the process itself would resemble a casino game. If you are a player be ready for the above mentioned outcome, just like him, losing it all. Our brain often overestimates the ability to predict outcomes, making falling into the gambling trap an unconscious act for many. It can happen in a growing market or after several successful deals. If you consider yourself a part of group of traders, your main task is to preserve (!) and multiply capital. Traders always work systematically, they need to constantly beat the market with their knowledge and skills. Every trade may become a loss and a trader is always ready for it. If you end up earning more than you lose, you’re doing everything right.
Why is risk management such an important part of trading? Simply put, it can help control losses. More precisely, risk management maintains the level of risk suitable for you (no matter how obvious it sounds). If it’s the level below the optimum – you won’t get the desired profit. If it’s above it – you won’t be able to handle short-term capital losses, and will end up acting on emotions. Don’t forget that psychology and self-control in particular play a very important role in trading. This is exactly what may lead to the loss of capital.
All that said, if we talk about beginners or not very experienced traders, the main task for them is to stay in the game as long as possible in order to get more experience and make more mistakes. Like any other profession, trading requires training and practice. It is fine to lose money in the beginning, just not too quickly. Of course you can predict the price movement 10 times in a row, but then may lose it all on the 11th transaction, simply because the volume of losses was unlimited.
There are two main recommendations for limiting possible losses:
- Limit the volume of a specific transaction
- Setting up stop losses
You can find quite specific, very well-put together tips on this matter online. Unfortunately, 90% of traders who read them won’t use any of it. Why? Because nobody wants to blindly trust “some rules” and the effect from propper risk management can be seen only over time, especially if the trader is lucky or one is playing on a growing market.
Once again, let’s say it limits losses (we have already touched on some points):
- Maintaining capital at an acceptable rate even in the worst of times. The level that capital can be restored to the initial level from and multiplied in the future.
- Free capital for investing in other opportunities that appear on the market. Getting stuck in a losing deal, trader closes themself off from other opportunities that could easily compensate a small loss. If you are a trader (not an investor!) with a brain HODL, get rid of it asap.
- Psychological health and a sense of control over your trading. Nobody ever says it is pleasant to close the loss. But the feeling of discomfort can pass very quickly (a day or even an hour), and you will probably rejoice for not having committed an even greater mistake.
The first rule of risk management is to limit the capital that you risk in any particular transaction. Most articles written on this topic mention 2%, and generally, you will not be mistaken if you stick to this value. Usually not all people are comfortable trading with such restriction (especially if your initial capital is small), so you need to understand the main thing – the more you bet on one particular deal, the more you trust the case. Try experimenting and find out what works for you.
Below you can see a graph that shows how this parameter affects capital losses. Let’s say you have a bad streak and you lost capital 5 deals in a row. This chart shows the percentage of your total capital, depending on the risk in each transaction.
The second rule of risk management is to put stop losses. Usually at this moment people immediately recommend technical analysis tools, so those who are not familiar often prefer to just ignore and do nothing. Therefore, if you have never done it, begin with adopting a habit of always placing them. How can it be done without resorting to certain indicators? Simple logic: potential gains should at least equalize potential losses. Moving on, if you count on 20% of profitability, try not to allow a drawdown below 20%. In this case, it is not worth it to place a stop-loss too close to the current price, otherwise they can work at any given moment. This is especially true for such volatile market like crypto-currencies.
For those familiar with technical analysis, here are some specific advice on stop losses:
Now that we know what percentage of the capital will be at risk and how to place stop losses, we can count the volume of each specific transaction.
The formula is pretty simple:
Volume = (risk * capital) / (admission fee— stop loss)
To make it even clearer, here is an example. Let’s say our capital is $ 10,000 and we chose the risk of 2% of the capital. We are going to buy a coin for $ 2000 and plan to put a stop-loss at $ 1800. How to choose the volume for this transaction?
Volume = (2%*$10000) / ($2000 – $1800) = $200 / $200 = 1
Constituents of formula: