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Risk Management: Why is cryptocurrency Trading difficult for novice Traders?

Risk Management: Why is cryptocurrency Trading difficult for novice Traders?

Trading cryptocurrencies is not only profitable, but also risky. Competent risk management helps traders avoid emotional decisions.

The proverb says that risk is a noble thing, but by trader standards it is quite expensive. And those who take reckless risks-drink champagne much less often than is commonly believed. In this article, you will learn how to control risks in trading, calculate the size of a trade, and what mistakes beginners make.

What is risk management in crypto trading?

In any trading, risk is the probability of losing a part of the capital invested in the transaction, and risk management, respectively — is the ability to determine this probability and control financial losses due to unsuccessful transactions.

Risk management is one of the key skills of a trader and it is on it that the stability of income and the share of losses from unpredictable price fluctuations depend. Three pillars of risk management:

Limit the risk of the transaction. The transaction risk amount is the difference between the purchase price (entry position) and the stop loss level. It is recommended that the risk of a single transaction does not exceed 1.5%-2% of the total amount of capital.

Limit the risk of capital. The general rule states that the total risk of all transactions should not exceed 20-25% of the capital. This means that if you close all orders with a loss, you should have at least 75% of the initial capital remaining.

Determining the profitability of the transaction. To compensate for possible losses and generate income, the ratio between income and risk should be 3:1 or at least 2:1. The amount of income is the difference between the entry position and the level of profit-taking (TakeProfit).

Compliance with these principles will avoid large capital losses and preserve a large part of it, which increases the chances of a successful recovery in the event of failure. Above are the general figures for the market based on 5-10 transactions per week, but experts distinguish three models of risk management:

Conservative-transaction risk of 0.6-1.5%, capital risk-10-15%. Mathematically, this is the optimal strategy that will allow you to consistently earn income in the long term. The potential income of such a strategy is estimated at 30-60% per annum, potential losses – at 10% per annum.

Moderate — risk transactions of 2-3%, the risk of capital 15-20%. It requires a good understanding of the market and a clear control of transactions. The potential income is 50-80% per annum, the potential loss is 60% per annum.

Aggressive-the risk of the transaction is 5-7%, the risk of capital is 25% or more. This is often an emotional strategy based on a desire to” recoup ” or a belief in an asset. Potential income — 200% per annum or more, potential loss — 100%.

As you can see, the trend is the same — the higher the potential income, the greater the risk of losing capital. The choice of a particular model depends on your goal of profitability, trading experience, frequency of transactions and the amount of capital. Beginners are advised to follow a conservative strategy to minimize the risk of losses in the still poorly known crypto market.

How to calculate the transaction amount-a specific example

To understand how risk management works in practice, consider a theoretical example and the calculation of the transaction size by a real trader. Admit:

The capital is $2,000;

A conservative strategy is used.

We want to buy the LTC cryptocurrency, the value of which at the time of the transaction is $100;

Technical analysis recommends placing a stop loss at $95.

The question is: how much can we afford to spend on this transaction and at what level can we fix the income so that the conditions of the conservative risk management model are met? Opening the calculator:

1.5% of our capital is $30 (risk of loss);

The amount of risk (possible loss) — 100-95=$5 per 1 LTC;

The
permissible volume and amount of the transaction, taking into account the risk of the transaction — 30/5=6 LTC ($600).

But this $600 is 30% of our capital, which is too much for a conservative risk management strategy. We reduce it to the recommended 15% and get the transaction amount of $300. In parallel, we will reduce the total risk of the transaction to $15 or 0.7% of the capital.

Now let’s calculate the level of profit-taking — the risk on each coin is $5, therefore, in accordance with the 3:1 ratio (see the third principle of risk management), the income level of each coin should be $15. Add this figure to the purchase price ($100) and find out that profit-taking should be carried out at the level of $115, then the total income from the transaction will be $345.

Now let’s see how such calculations are carried out by a real trader:

The screenshot shows the size of the trading capital for the ETH cryptocurrency (bottom left) and it is 238 USDT. The amount of acceptable risk of the transaction is at the level of 1.5% – $3.57:

This screenshot shows the cryptocurrency rate (purchase at $1242) and the level at which we set a stop loss is $1200:

In accordance with the above data, we calculate the risk on a single coin, which is $42, as well as the profit-taking level with a 2:1 risk-income ratio of $1326. That is, we can buy 0.085 ETH ($105) to meet the acceptable risk of the transaction, although this ignores the requirement for total capital risk.
Go to the opening of the order and enter these numbers. Do not forget to open a stop loss at $1200 to avoid subsidence. As you can see below, the price of ETH broke through the level of $1450, that is, the forecast was justified and the transaction was closed when the recommended yield level was reached. The recorded profit from the transaction was $112, net income – $7.

For a visual demonstration of risk management in action, data from the Bynarix cryptocurrency exchange is provided. If you do not have a trading account on the exchange yet, you can use Bynarix to test the work of risk management on several orders.

Mistakes of novice traders

Trading — work with high risks, which ruin most beginners, ruthlessly taking away their capital. In order not to lose all the funds accumulated for trading and live up to the first profit, you need to avoid the main mistakes of novice traders:

Neglect of diversification. The “don’t put all your eggs in one basket” rule works always and everywhere. And it especially works on the crypto market, where the fall of one coin can pull an entire cluster of assets to the bottom. Therefore, you need to invest in various cryptocurrencies with minimal correlation between them.

Emotional transactions. The desire to win back on one trade for weekly losses, a series of closed “minus” orders, or vice versa — constant luck leads to the adoption of rash and spontaneous decisions. You can’t feel the market in your gut, you need to analyze it and draw concrete conclusions based on the data.

Aggressive trading strategy. Often beginners trade with too high risks, investing up to 25% of the capital and even more in the transaction. In the absence of experience and complete confidence in your actions, trading aggressively is playing roulette on your trading capital.

“Faith” in the position. It is often psychologically difficult for novice traders to close an order that goes into negative territory or to fix a profit on an uptrend. At such moments, greed turns on and the inability to stop in time leads only to large losses.

Ignoring the stop loss. Automatic closing of a trade is important not only for a clear definition of risk, but also for closing an order in any conditions, which is very important in online trading. Even if you are not at work, there is no Internet or the exchange’s website is frozen, the stop loss will work and prevent losses due to a sudden price reversal.

Trading always carries risk, but it is subjective and is created only with insufficient knowledge, lack of understanding of their own actions and inability to predict their consequences. The above information will help you take the risk under control and turn it from an unpredictable threat to a random, but considered probability of events. Only your actions create risk and only your actions prevent its consequences.

Author: Oleg Marchenko, trader-analyst of the Binaryx digital asset exchange, author of the Binaryx Academy knowledge base on trading and cryptocurrencies.