Why Risk Management Is the Most Important Concept For You Right Now
Risk management is a core component of every investor’s skillset. In crypto it is even more relevant due to the innate volatility and constant uncertainty. Risk management will be responsible for at least 50% of your success and there are no fixed rules as every trade and every trader is unique.
The Human Factor
The strongest human emotion is greed and it is responsible for burning all the profits of a trader. When your coin is going up it is hard to offload it, very hard. You check Twitter and everybody is calling “moon” so you quickly move over to Reddit, much to your surprise everyone is calling “moon” there as well. Your special coin is going to be the one that changes everything, volume is increasing, and there is no stopping it! We all know how this scenario plays out, there will always be a correction, a crash, FUD and a drop. The trader needs to be selling all the way to the top. This is where it gets personal.
Taking Profits
Some traders will sell at 15% others at 100% it completely depends on the nature of the coin in question, what the current price is, technical analysis, volume, social networks, ‘vibe’ and the whale’s reactions along the way. There is only one thing for certain. You have to sell on the way up and please, do not wait to sell at the top, the magical land of goblins and rainbows; it is not going to happen. Manage your sell orders in anticipation of previous resistance levels and allocate percentages to sell based on your intention with the coin. If you are holding long term, you won’t want to sell out of your entire position and if you have lost faith in the coin or were just looking for a quick trade you will sell more aggressively.
A good rule for what you do with your newfound wealth after taking profits looks something like this.
- 30–40% to BTC so you can grab bargains in the desperate and bloody times.
- 60–70% to reinvest in the same coin or a better deal across the market.
By fighting against the urge to re-invest 100% of your profits into the next “hot” coin you not only prepare yourself mentally and economically for hard times but you also follow a strategy for trading success. Buying the bargains when fear runs thick across the market is the path of the bold and the path of the rich.
The Importance Of Diversification
Next we need to talk about diversification and the size of your portfolio. This is a long topic with a lot of conflicting opinions. The first rule is to never go all in and surprise, surprise, this is exactly what greed will try and force you to do. A strong portfolio should be spread across at least 5 coins. The main rule to follow isn’t a complex formula like “never have X % more than X number of coin”. The limit is simply; the amount of coins you can control by yourself while properly tracking them.
A common rule of thumb is to not add more than 15% of any coin to your portfolio and never start a trade that will take out more than 2% of your portfolio if it goes badly. After backtesting a strategy of diversification Ray Dalio found that if you can have 10 or 15 uncorrelated bets, all with roughly the same return you can cut your risk by 75–85%. One problem here is that all cryptocurrencies are correlated to some degree (the market usually moves somewhat in tandem). Even if Ray Dalio’s rule isn’t as effective as if they were uncorrelated assets it will still minimize your overall risk and exposure.
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