Basic Crypto Trading Strategy Part 2: Establishing a Plan of Action
After determining the proper risk profile and trading style most suited towards the appropriate trading time horizon, the next step for building the best strategy is establishing risk and reward parameters. At its core, investing is all about taking calculated risks.
However, the rewards must always outweigh the risks, otherwise the equation will inevitably be skewed in the direction of generating losses instead of gains. If the reward side of the equation doesn’t properly compensate an investor for the risks being taken, all capital may ultimately be forfeited.
Establishing Crypto Risk and Reward
While it is commonly held that professional traders have a very high success rate, the likelihood of executing a trade in the right direction that generates positive returns is surprisingly less than 50%.
In fact, most figures point towards a 30% success rate amongst the most seasoned professionals, implying that risk-reward must always at least grant the opportunity to break even if not outright profit. A common ratio that is employed for risk-reward is 1:3.
Taken in the context of a 30% success rate, a trader employing this model would likely return a net positive value of 2. For 10 trades, 3 successful trades will generate a positive value (profit) of 9 (3 x 3) whilst 7 unsuccessful trades will generate a negative value (loss) of 7 (7 x 1).
Subtracting the losses from the profits implies that over time, a trader would produce profits, with an elongated number of data points likely supporting this view.
Formulating a Cryptocurrency Trading Game Plan
The concepts of risk profile, time horizon, and calculated risk are all eventually incorporated into a trading game plan which outlines the entire strategy an investor deploys from start to finish. It all starts with having a reason to get involved in trade.
Whether fundamental or technical in nature, uncovering a catalyst for entering a trade is essential. It could be a regulatory development or even a shift in market sentiment, but having a reason to open a trade is a must, and should ignore emotion as best as humanly possible.
After finding a reason to enter a trade, the next step is determining an entry point for the trade and setting the corresponding risk and reward parameters. If available, a helpful way to accomplish this type of setup is entering a limit or stop order and accompanying said order with a stop-loss and take-profit entry to automate the process. In the same vein, after determining risk and reward and setting the appropriate parameters, establishing an exit strategy is paramount.
Win or lose, exiting is imperative, as letting a trade run can result in unintended consequences. The first, and most important rule of investing is that “you can never get hurting taking profits.” Part of this comes down to building a well-informed strategy that sets limits, evaluates entry and exit points, and possibly incorporates an indicator or two to form a system.
In Part 3 of our series, we will discuss some of the popular indicators traders use to form systems that are designed to ensure their long-term success.
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