New to Trading and Investing? Start Here and Learn All About Managing Risk
A complete guide to managing risk when trading Cryptocurrencies: risks, dangers, and mistakes that threaten your money. Learn why and how to manage risk when trading.
As a trader or investor, your number one job is to protect your capital.
Fail to do so, and you will never make it. One mistake can take it all.
I am a trader who focuses on Bitcoin. With my trading-focused publication “Trading Meditations,” I’ve been trying to put my experiences and lessons out there for all to learn from.
Remember, in trading and investing, making the money is the easy part, keeping it the hard part.
If you’re not yet a Medium member and can’t afford the price of the subscription, don’t worry. You can read my content for free by subscribing to the Trading Meditations Newsletter.
This is a post about protecting your capital from all possible threats.
Let’s start with a word of warning. I started actively trading in 2017, and I went all in full-time. That was a mistake, as I was nowhere near ready! Don’t go down this path unless you:
- Have been successfully trading for years (not months).
- Have amassed a considerable portfolio. At least 10x what you would spend in a year is a good start, but more is favorable.
- Have a few years of life expenses saved up and don’t need to trade them. They are separate from your trading account.
- Know the importance of managing risk and take it seriously!
How to read this article and make the most of it.
In this extensive post, I will summarize a complete risk management overview of trading and investing, especially pertaining to Bitcoin and Cryptocurrency markets.
Bookmark this post, share it and consult it often. It will save you a fortune in the long run!
For the whole lesson on managing risk, follow the links and study each article separately.
- This is only a summary of the lessons contained within each article — an overview.
- I go into detail and reveal my experiences, mistakes, and lessons in linked articles. It includes charts, images, and data.
- It’s a list of my risk management-focused posts gathered and summarized in one place for ease of access and a better understanding of the problem.
- You can read the whole article in one sitting, or you can do it one topic at a time. I would suggest the latter.
Use the index below for reference and orientation.
Index of content on the topic of risk management in trading:
- Introduction to Risk in Trading and Investing in Cryptocurrency Markets
- Trading Cryptocurrencies is Dangerous — How To Protect Yourself and Your Money
- What Are the Greatest Risks in Trading Coming From the Market Itself?
- How Well Do You Know Your Trading Tools? — Manage Risk of Cryptocurrency Exchanges
- The Biggest Trading Mistakes: Why You Are the Greatest Danger to Yourself
- Is the Market Acting Strange? — When in Doubt, Get the Hell Out!
- Manage Risk on Every Trade — No Exceptions!
- Where to Place Your Stop-Loss Order?
- Alternative Risk Management Strategies to Using Hard Stops on Charts
- Don’t Like Using a Stop Loss? Here’s a Quick Guide to Hedging
This post is public, so feel free to share it, tweet, post, guest post, or use it as a reference. Help me reach all the inexperienced traders out there eager to learn.
Chapter 1:
Introduction to Risk in Trading and Investing in Cryptocurrency Markets
If you wish to one day thrive as a trader, you must first make sure that you’ll survive no matter what! Learn about risk and all the dangers that prey on you. First, you survive, then you thrive.
Read the full article about the introduction to risk in trading and investing.
What is this chapter and the article about:
- What are the key risks in trading and investing in cryptocurrency markets?
- How can I protect myself from risks when trading cryptocurrencies?
- What is risk tolerance, and how can I determine mine?
- How much money should I risk in the markets, especially as a beginner?
- How can I manage risk while trading cryptocurrencies effectively?
- What dangers should I be aware of as a trader, and how can I mitigate them?
Risk is inherent in life and in trading.
Without taking on risks, we can’t make any money. There is no avoiding risk. We must learn to manage it.
If breathing or walking down the street is inherently risky, imagine how much risk there is in exposing your money in a world full of hungry vultures, technology beyond your comprehension, and a market subjected only to the Gods of chaos and randomness. Fun, for sure, but extremely risky.
Control what you can. Let go of the rest!
Always identify what is in your control and what isn’t and act accordingly.
- What can I actually control in this matter?
That is the question you must always ask yourself when thinking about risk because there are always steps you can take to mitigate the risk, even if you cannot eliminate it entirely. It’s called managing risk, not eliminating risk.
I explain this point in the example of riding a motorcycle. A dangerous activity that nonetheless brings me immeasurable joy. There are risks I can foresee and control, but there are things completely beyond my control. The same is true in trading.
Determine your RISK TOLERANCE.
As a trader, I am as risk-averse as it gets. The thing is, I didn’t necessarily start out that way, but I have had to learn the hard way what risk really means in this market.
They say that a biker (motorcyclist) isn’t a biker until his first fall. And I tend to agree with that statement wholeheartedly. I suppose one could say one isn’t a trader until his first liquidation, bear market, or total loss of funds, but that might be taking it a bit too far. I hear there are people who’ve managed to learn the lessons without such scars. I’ve never met one, though.
How much money are you willing to lose?
Take account of all of your financial possessions and determine how much money you are willing to risk in the markets.
Never risk more money than you’re willing to lose.
Really think about how much money you can see yourself losing because you will lose, especially in the beginning. Maybe not all, hopefully not all. But losses are inevitable. That’s also why I’m writing about managing risk, to at least give you a chance of surviving these perilous waters. And please don’t sell your house to go all in on Bitcoin or your new trading endeavor.
Only you can assess what the right number is for you.
It will depend on your personal and financial situation. I would advise you to risk up to 10% of your liquid financial stack on trading (the whole trading portfolio, not risk per trade).
Do yourself a favor and don’t think from the perspective of “how much money/profits I can make,” but from “how much money/losses can I take”!
Always assume everybody’s out to get you and take your money!
Trust no one and nothing in this game. Protect yourself at all times because, just like with riding a motorcycle, all it takes is one mistake, one moment of weakness, one second of complacency, and boom, life as you know it is over.
Think about how it would feel and what it would mean for you to lose it all. To lose 50% of it, 30, 20?
When you’re establishing your risk parameters, you’re also defining your pain tolerance. Losing isn’t fun, and losing something like half or, god forbid, all of your money can bring about a living hell for any one of us.
Always manage risk, dear trader.
Chapter 2:
Trading Cryptocurrencies is Dangerous — How To Protect Yourself and Your Money
What dangers prey upon you before you even open your first trade? Third-party risk, hacks, security, and privacy.
Read the full article about managing risk in trading cryptocurrencies.
What is this chapter and the article about:
- How to secure my computer for crypto trading?
- How to protect my crypto wallet from hackers?
- Importance of unique passwords and emails.
- What are the risks of trading on small exchanges?
- How to choose a safe and reliable crypto exchange?
- Risks and benefits of margin trading in crypto.
- How can I mitigate the risk of using third-party exchanges and wallets?
- What are the pros and cons of self-custodial wallets versus custodial providers?
- How can I ensure my personal safety while engaging in crypto trading?
There is risk in every corner of this market, but none so dangerous as the one between your ears!
Forget about having four monitors and a Bloomberg terminal without first taking care of the basics, and the basics of managing your money start with security.
How is your internet and computer setup?
Is it secure? I’m talking about routers, WI-FI, and so on. Lock them up with passwords.
- Ideally, you would use a separate, clean computer for trading and accessing your online accounts.
- Preferably you would avoid the Windows ecosystem, as it is the most popular one and littered with potential dangers. Linux or Mac OS are the better choices.
- Use good antivirus and firewall software, and at least lock the user account on your computer.
- Use strong, unique passwords for all of your accounts, and that doesn’t mean just the exchange accounts.
- Use unique email accounts for each exchange account and protect them.
- Use secondary login options (Google 2FA or other) for all the connected accounts.
Backup.
Don’t forget to backup all the passwords and 2FA, wallet, and access information. Preferably do it on paper, far away from your computer, and store it separately in at least two different locations. In case of some ultimate damage, like a fire or something. Better to be safe than sorry.
You might also want to think of the worst-case scenario in which you cease to exist. Will your loved ones have access to your funds, and will they know where to find your backups? Will they know how to use them? When using banks, things are simple in this regard, but in the world of crypto and self-banking, we must take some additional precautions.
It is estimated that about 20% of all Bitcoin that will ever exist (21 million) has been lost in one way or another. We’re not exactly good at being our own bank, that’s for certain.
Privacy and anonymity.
If you can, completely separate your social media presence and accounts from your trading accounts, making sure there is no connection either in name, login information, or basis (email, phone, identity).
Needless to say, don’t show your wealth or brag about your trading and portfolio to people on the internet. That’s just asking for trouble.
Think about your privacy when accessing your money on the internet. You can use the Brave browser (or some other privacy-focused browser), control your privacy on your phone as much as you can (to hell with convenience — safety first), and use VPN services or Tor network.
The rest is classic, timeless advice in internet security:
- Don’t be a naive idiot.
- Don’t open attachments from unknown people.
- Don’t download suspicious shit.
- Don’t open weird emails.
- Don’t ever give anyone your personal or account information unless you can verify that they are who they say they are (exchange verification and so on).
If something sounds too good to be true, it probably is.
No, you didn’t get contacted by the last prince of Nigeria, who desperately needs your help in getting his insane fortune out of the country.
And no, if you send some random dude on the internet 1 ETH, ain’t nobody gonna send you 10 ETH back!
Don’t be an idiot! Just ignore these obvious scams, please.
Third-party risk.
What is “third party risk”? It’s all the risks associated with using third-party applications, exchanges, wallets, and so on.
With crypto in particular, when you hold some Bitcoin, for example, on your chosen exchange, you need to realize that in the worst-case scenario, these aren’t really your coins. They belong to exchanges.
If something goes wrong, you will lose everything!
Please read the whole article to learn how to mitigate this risk and protect your money. There are a few important steps you need to take in order to be free from this danger. When in doubt — remember FTX!
Chapter 3:
What Are the Greatest Risks in Trading Coming From the Market Itself?
Markets are chaotic and dangerous playing fields. There are an infinite number of dangers and risks involved with trading and investing. Are you protected against them all?
Read the whole article on trading and investing dangers presented by the market.
What is this chapter and the article about:
- What are the risks associated with trading in the market?
- How can I protect my investments from market risks?
- What is the importance of risk management in trading?
- How do trading systems and algorithms interact with market conditions?
- What is the impact of one bad trade on overall trading success?
- Can markets be predicted with certainty?
- What are black swan events, and how do they affect trading?
- How can I manage risk in leveraged trading?
- What are some common trading mistakes related to risk management?
Randomness and unpredictability of the market
Markets are always unpredictable and, for the most part, completely random ecosystems of buyers, sellers, and enablers (exchanges, market makers…).
The price may sometimes trend, and the charts may repeat certain fractals and patterns. Trading systems and algorithms may work pretty well sometimes, but never always! That’s important. Very important. Nothing works always.
- Every system, no matter how high its win rate, will have to go through losses.
- Every edge in the market will come upon a situation where it simply doesn’t work.
- Every algorithm will be met with market conditions it wasn’t programmed to handle.
- And every trader will be wrong on his trades, at least from time to time.
For a realistic illustration, the best traders in history have self-proclaimed to have between 40% and 60% win rates on their trades.
You can be the best trader that ever lived in the history of this world. But even with a 95% win rate on your trading (heck, even 99%), that doesn’t make a speck of difference.
One mistake can end it all
If you don’t have good risk management systems in place, if you don’t protect your money first, you will lose it all!
I belonged among those traders who almost never lost once upon a time. My winning streak was epic. I felt infallible. At the time, I was trading one of those “balls out, all in, buy every panic” strategies in a bull market that work great until they don’t. And then they take it all!
In the article, I try to illustrate such a possibility with an intimately familiar example. I’ve been there and have made all the mistakes imaginable.
One bad trade, left unprotected, can wipe out years of success! Just one bad trade. One bad decision. One freak occurrence in the market. One fucking black swan event that was never supposed to happen. Everything you’ve worked so hard for is simply gone.
Focus on protecting your money first
Trading is predominantly managing risk and only secondarily seeking profit.
Warren Buffet has said that his two most important rules are:
- Never lose money!
- Never forget rule number one!
All of my more significant losses in the markets were down to one single mistake. Not managing risk properly.
- Either not cutting the trade when I knew I should have or putting too large a position on in the first place.
- In spot trading, the losses and associated pain were rather contained and dragged out.
- In leveraged trading, the lessons came much faster and in a much more brutal fashion. Think — losing everything in an hour, not days or weeks!
What are some of the most important lessons I’ve learned about risks posed by the market itself?
- First and foremost, markets can and will do whatever they want, and there is nothing you or I can do about it.
- Markets can stay irrational longer than you can stay solvent. You really shouldn’t go against the market.
- The market is always right. No matter how unintuitive or plain wrong it seems at the moment or how good your thesis is.
- Prices in a bull market can go a lot higher than anyone expects, and in bear markets, a lot lower for a longer period of time than one expects.
- Trying to guess tops or bottoms tends to be a fairly costly and problematic affair, even though it is a tempting one. Your EGO might demand it.
No one can predict the market with any substantial degree of certainty. No, not even your favorite influencer, trader, investor, or giant giga-brain individual. Predictions, while fun, are of no real use in trading or investing.
Anything can happen in the markets.
Even if the odds of something catastrophic happening are small, the threat is still real and must not be ignored!
- Black swan events happen.
- Exchanges go broke.
- Money gets stolen.
- Crashes in the market happen.
- There are always some news and information you aren’t privy to.
Things aren’t always what they seem.
There are many players in the market, some of them with really deep pockets that may have developed some, let’s call them “creative” solutions to the problem of liquidity in moving large money around.
In order for them to successfully trade certain instruments, they have to play sort of mind games with the other market participants. Like Orca, killer whales, they coordinate between themselves and herd their prey into desired killing fields.
You can read about fakeouts, liquidity pools, chart painting, spoofing the order books, and more in two articles dedicated to recognizing these tricks in the market:
- Market — The Great Trickster, part 1
- Market — The Great Trickster, part 2
Chapter 4:
How Well Do You Know Your Trading Tools? — Manage Risk of Cryptocurrency Exchanges
Do you know every order type, tool, option, and derivative on your cryptocurrency exchange? Are you familiar with stop hunts, slippage, exchange stability issues, and the cost of fees in trading?
Read the whole article on trading exchange, broker, and engine risks.
What is this chapter and the article about:
- What are the risks associated with executing trades in the market?
- How can I protect myself from exchange instability and order failures?
- What are the potential issues with using API-enabled trading applications?
- How can I ensure my orders are executed during volatile market moments?
- How can I prepare for technical issues during critical trading times?
- How do trading fees and slippage affect different trading strategies?
- What are stop hunts, and how can I avoid falling victim to them?
- How do institutional traders execute large orders in the market?
- What are the signs of market manipulation, and how can I recognize them?
Let’s look at some of the risks you can encounter while executing the trades themselves. These potential risks will, of course, depend on the exchange and the type of trading you do. One of the biggest differences stems from the type of market you trade, spot coins, commodities or stocks, or margin-based futures, a.k.a. leveraged trading.
The latter comes with a plethora of additional risks and dangers, so only trade with leverage if you know what you’re doing. And definitely not if your first question is, “What leverage do you use?”
Exchange stability.
You’ve not known panic until you have a giant position open on an exchange, in the middle of a market-wide panic drop, and no order to sell goes through!
All you see on your screen are error messages, connection issues, and order failure alerts. You keep pressing the buttons and keep setting up orders, but nothing goes through. You can even get locked out of the exchanges at the most inopportune times. Many, including myself, have lost lots of money in those types of situations.
So how can you protect yourself from these types of dangers?
- By researching exchanges and trading only on the most stable and safe ones.
- If you’re using an API-enabled trading application, those same problems could be encountered there as well, inflated by potential exchange stability issues.
- Set up the desired orders upfront before these volatile moments in the market even begin. Entry, take profit, and stop-loss orders.
- Use only “market orders” for risk management!
You should have a plan B for your own technical side of things.
What will you do if your internet connection falls at the most problematic time?
- Do you have a mobile access point ready and know how to use it?
- What will you do if your computer crashes or simply dies on you, and you have to react fast in the market?
- Do you have a backup computer, tablet, or smartphone set up to take over? You should.
Be prepared, don’t leave yourself exposed to silly problems that can be avoided!
Control all that you can control.
Research your trading exchange thoroughly!
Familiarize yourself with the fee structure and the options available to you. What type of orders will you be using? When? Why? In the article, I explain the types of orders I use and the logic behind them.
Exchange fees.
If you’re a day trader and make lots of trades all the time, fees will be of greater concern to you. They add up really quickly and can completely annihilate your trading edge if you’re not careful.
If you’re more of a swing trader, you don’t have to worry about trading fees all that much apart from the funding fee when trading perpetual futures contracts (leveraged trading).
You have to understand what you are trading and know when you should trade futures, spot, or perpetual futures. The danger here is twofold: expensive fees and failure to execute orders.
Order execution slippage.
What is slippage? Let’s see how Investopedia defines it:
“Slippage refers to the difference between the expected price of a trade and the price at which the trade is executed. Slippage can occur at any time but is most prevalent during periods of higher volatility when market orders are used. It can also occur when a large order is executed but there isn’t enough volume at the chosen price to maintain the current bid/ask spread.”
Problems of damage incurred by slippage are more pronounced with traders who trade with bigger accounts, but they can be a problem for almost anyone if you trade in illiquid markets, of which there are plenty in the crypto space.
Know the liquidity limitations of your market and adjust your trading size. Slippage can be a problem in liquid markets as well if you’re trading on leverage. The problem of fees and slippage is very prominent in the world of day trading, with the potential to kill even the best-looking strategies.
For my suggestions for combating this problem of slippage:
Chapter 5:
The Biggest Trading Mistakes: Why You Are the Greatest Danger to Yourself
We must be very careful when executing our trades or investments. There are a million things that can go wrong, and mistakes can be expensive. Here are the most popular trading execution mistakes.
Read the whole article about the biggest trading mistakes when executing our trading here.
What is this chapter and the article about:
- What are fat finger incidents in trading?
- How to avoid fat finger incidents in trading?
- How to profit from fat finger incidents?
- How to prevent trading execution mistakes?
- How dangerous is being careless when entering a trade?
- How to avoid account liquidation in leveraged trading?
- Risk management strategies for leveraged trading.
Fat finger.
We talk about a fat finger incident, when someone, usually a larger trader, suddenly sells (or buys) an inappropriately large position and causes the market to move significantly in price. This results in a large but short-lived spike in price.
This is more of a big player in an illiquid market type of problem, but since crypto is full of those ecosystems, we really should talk about them. You can find these unfortunate souls in the charts by spotting an unusually large short time frame candle (from a few seconds up to an hour candle) that really sticks out, accompanied by exceedingly heavy volume.
Those two data points, a very big short-time candle and a spike in volume, indicate that someone has sold or bought a large quantity of whatever the chart contains in a very short time. So either a market sell order or a mistyped (fat finger) limit order that just ate up all the orders on the way down (or up).
It usually only happens on one exchange, not all at once.
That’s a definite hint that you’re dealing with an anomaly. In the above-mentioned article, we take a closer look at the characteristics, dangers, and opportunities presented by fat finger incidents.
Miscalculating or mistyping order values.
I know this sounds silly, but in practice, especially if you’re hurrying things for whatever reason, it’s a lot easier than you think. Especially when trading in Crypto with all the different denominations, base currencies, and differences in pricing, from 0.0000001 USD to 70,000.00 USD per one Magic Internet Coin of your choosing.
- For instance, when you trade with Bitcoin, things can get really tricky, really fast, especially if you trade small sizes. One zero or decibel was wrongly placed, and that’s a 10x mistake in order size.
- You have to be especially careful when trading with leverage and having the open option of getting in way over your head.
- The same goes when you trade in altcoins, and your denominator (your base currency) is Bitcoin or Ethereum.
- When you’re using a base currency that is not your native currency, such as trading out of USD, and you’re used to using YEN in your daily life, for example, things get confusing rather quickly.
- Also, keep in mind that when you trade in some other currency than USD or USDT, for that matter, charts and patterns can be somewhat irrelevant. Always check the chart that has the most eyes on it.
Double and triple-check everything before clicking on the buy or sell order!
Give me leverage, baby!
If you’ve decided to play in the magical land of 100x leverage, you need to be even more careful. Calculating risk per trade and knowing just what kind of positions you should open is a bit more complicated when dealing with leverage.
For now, let’s just say that what kind of leverage you click in the order box doesn’t matter one bit. I need to say this again — the amount of leverage doesn’t matter!
What matters is how much money you are going to lose if you’re wrong on this trade.
You really need to come to terms with this mentality. Engrave it in your mind. Let it be your starting point.
And never, I repeat, never put on naked trades with leverage!
When using leverage, things can go wrong in an instant and very wrong indeed. Account liquidation wrong! We’ve all been there. It’s highly likely you will be as well. So let us remember the number one commandment for trading:
Risk only what you are willing to lose completely!
- How much am I willing to lose if I am wrong?
- Where am I wrong, and where am I getting out?
- What size position can I then open?
Chapter 6:
Is the Market Acting Strange? — When in Doubt, Get the Hell Out!
What should you do when something unpredictable happens in the market, and you don’t know how to trade it?
Read the full article on how to act when the market surprises you.
What is this chapter and the article about:
- How to trade during chaos and blood in the streets?
- How to protect your money in volatile markets?
- Strategies for surviving unpredictable market situations?
- How to overcome fear and uncertainty in trading?
- How to assess risks and calculate risk-reward in unpredictable events?
- How to identify opportunities in unpredictable market conditions?
- Importance of emotional control and mindset in trading.
- How reliable are the news sources when chaos strikes the market?
There will come a time in the market when you’ll be completely lost.
Things that shouldn’t be happening will be happening, such as stablecoins in the crypto market losing their peg to the dollar, banks going out of business over the weekend, the Swiss Franc losing its peg, or some crazy price action that simply makes no sense and has caught you completely off guard.
Stop, close all your positions, and reassess!
Your first job is to protect your money and get your mind right. You’re of no use to anyone if you’re all emotional and either scared or hyped up! Take a step back, look at the big picture, and get oriented on the situation.
You don’t have to play in every market condition.
“Choose your battles” goes for life as it does for trading. Different traders thrive in different conditions, and that is okay. You don’t have to master all of them to make money in the market. In fact, it is much better to focus purely on your bread and butter and then hit the gas when the planets align for your system.
The one big advantage we retail traders have, apart from being able to work in our underpants, is that we can choose when to play and when to stay away!
It’s all fun and games until it’s not!
One mistake in such an unpredictable and volatile situation can wipe your account clean! It’s perfectly fine to play a little and dip your toes in the water. Buy that collapsing stable coin, buy the blood, short the pump, and jump on the news bandwagon. No problem.
But, and yes, there is a but, do it with a small position!
What’s the news? Why is this happening?
Treat every information and news with some level of disbelief and skepticism because the truth is that you can never know the real, full story, especially not in the first hours or days of any given event.
You cannot and need not take advantage of every single opportunity.
Markets are open all year long, crypto even 24/7. You’re not missing anything. You need rest too. Your time will come. In reality, a few good trades can make a year for a trader.
When the situation in the market is unfavorable, take a step back.
- Breathe, take a break, go on a holiday. There’s no point staring at the screen and feeling all that FUD and FOMO if you don’t know how to trade this situation. There’s no point risking money, either.
- Or you can sit at the screens and absorb all the information that you can so that the next time something similar happens, you’ll be better prepared to take advantage of it.
Chapter 7:
Manage Risk on Every Trade — No Exceptions!
Don’t let one trading or investing mistake ruin you and set you back years. Do you manage risk and protect your money on every single trade? You really should!
Read the complete article on the dangers of buying the dip.
What is this chapter and the article about:
- Do you manage risk and protect your money on every single trade?
- How to manage risk in trading and investing?
- What are the common mistakes to avoid in trading and investing?
- How can I protect my portfolio from losses?
- What are effective strategies for managing risk on every trade?
- How to calculate the position size based on risk parameters?
- What are stop-loss orders, and how do they work?
- How to stay objective and control emotions while trading?
- What are the consequences of failing to manage risk in trading?
I don’t need risk management — I never lose!
When I started, I learned a trading strategy with a very high win rate, and I rarely lost money trading that strategy.
I felt like I had this game all figured out. I could see this pattern repeating on every chart I looked at, crypto, gold, stock, and indexes. It didn’t matter. Everything was so clear to me. It was so simple, so beautiful, so natural. I understood it, felt it, and clicked with the markets instantly. It did seem like the holy grail of trading. I practically couldn’t lose.
It gave me a false sense of security and certainty. But that was just an illusion. For those things don’t exist in the world of trading.
Even though this trading strategy almost always wins, it has one deadly flaw. It’s nearly impossible to manage risk when trading this system. The more wrong you are on your trade, the more you double down until you run out of bullets. And then you wait for the market to correct the exaggerated move you faded.
Yes, you guessed it, I was a knife-catching specialist.
The bloodier the streets, the bigger the panic in the air, the scarier the FUD, the more fun I had, and the more money I made. Once I fully trusted the system, I went all in every single time. Boy, was I on a roll!
Until one day, I got caught in one of those 1 in 100 possibilities, a coin that just wouldn’t go back up — ever.
Protect your money always — no exceptions!
I don’t care how sure you are of your idea, project, coin, or strategy.
Anything can happen at any time in the markets!
Deal with it. Embody this philosophy. Breathe with it. Become one with uncertainty. Always be prepared for the worst-case scenario. Remember, all it takes is one bad mistake, and you’re out!
On the other hand, focusing on protecting your capital first will put you ahead of 99% of the traders out there in the long run.
How much do I risk?
The first thing you need to do is come up with a number or a percentage of your trading portfolio that you are willing to risk on this (or any) trade.
Ask yourself: How much money am I willing to lose on this trade if I’m wrong?
I would say that it’s essential that you can survive at least ten consecutive losses without making too big a dent in your portfolio or, even more importantly, in your mindset.
- Decide on a number of a percentage you are willing to risk and lose on any trade.
- Use that information to calculate and determine the size of your position.
- Pinpoint your exit price on the chart. Where will you put your stop, for example?
- To calculate the maximum size of the position you can now open, use this formula:
(risk per trade) / (distance to stop loss) = y (position size)
See the full article for more details.
There are many ways of managing risk.
The simplest way is using a stop-loss order for every position you open. It can be a mental stop, meaning that you decide up front on a point at which your trading idea is invalidated (why you opened the trade), and get the hell out manually, but I wouldn’t recommend it.
It takes impeccable discipline to cut trades in the heat of the moment. Most of us, don’t have it!
Should you set up a limit or market stop loss? My advice? Market! Always. Too much can go wrong on a limit order. Slippage and fees are the least of your problems when things go haywire in the markets.
Never remove your stop loss order once it’s placed. Chances are that your mind is being compromised either by fear or greed. You’ve put it there for a reason.
I would advise against trading naked — without protection. That is how bagholders are born every season. Traders who, against their will, become long-term investors.
Have a plan.
Always set up a plan for your trade before you open a trade. When your mind is fresh, and your view is at least slightly objective. And stick to it. Remember, you’re smartest when unattached. Once you’re in a trade, all objectivity will be lost, and emotions, strengthened by new biases, will be prevalent in your thinking. Of course, stop-loss orders aren’t the only way to manage your portfolio and trading.
You can conservatively manage your trading positions and play much smaller, or you could, for instance, hedge your positions.
The latter entails more understanding and risk; the former might reduce your profits. But all of it depends heavily on your style of trading and personality.
Chapter 8:
Where to Place Your Stop-Loss Order?
Tired of frequent stop-outs? Where should you place your stop-loss order for effective risk management in trading?
Read the whole article about placing of stop-loss orders.
What is this chapter and the article about:
- Are you often getting stopped out of your positions?
- Are you thinking about abandoning stop-losses altogether?
- Where to put your stop loss?
- Should you use wide stops or tight stops?
- How to optimize stop placement, avoid unnecessary losses, and strike a balance between risk and reward?
Listen, I get it. I wouldn’t say I like using stop-losses, either. I hate it every time the market swings lower to take me out and then continue in accordance with my original plan. It happens all the time, no matter what I do regarding placing stop-loss orders. One has to make peace with that fact. Your stops will be taken out, and a small percentage of your capital will be gifted to the market Gods.
Call it a tax on trading or an insurance policy protecting you from severe draw-downs. Most people spend money every year on insurance for their car, house, and health to protect what they value most from taking on too much financial damage. This is no different.
A safety tax for making sure that no matter what happens in the markets, you’ll survive to fight (trade) another day.
As annoying as getting stopped out is, it pales compared to the pain of a significant draw-down, especially if you should have known better and chose to remove the stop to save a few bucks but ended up with a giant hole in your portfolio.
Optimal stop-loss placement
The placement of your stop order can be optimized, depending on your chosen strategy. But I must disappoint you; there is no “one cure for all” solution here.
You must monitor and journal your trading and note where the price likes to hunt for stops and where your stops usually survive. Since I don’t know your trading strategy, I will mention a few ideas and clues to look for in your trading.
Stop hunts
There is a joke meme that you should put your stop where you usually enter your trades. It’s just a joke, but there is some truth to it.
In my trading, the price “hunting for stops” or simply “faking moves” is the norm, not the exception. That’s why I’ve based most of my trading upon that fact.
I rarely trade breakouts unless they are exceptionally strong and backed by other factors (time, accumulation, volume, news…). I mostly expect that all breakouts (on either side of the support/resistance/pattern levels) are nothing more than stop hunts and fade them.
Text-book stop loss placement
Now if you’re trading a support level, for instance, you would generally enter the long position a little above the support line and place your stop somewhere below the support line.
Unfortunately, that is expected in the market, and the market likes to play liquidity games at these levels.
Trend matters
In a strong bull trend, support often gets front-run, and price action tends to break higher through resistance, at least for a while. In a bear market, the opposite is usually the case.
So where do you put your stop for it to be safe?
As far away as possible from the expected price action would be the most logical conclusion, would it not?
But there is a problem with that. If you move your stop loss far away from your entry, you are taking on more risk if you end up being wrong and get taken out. You lose more money.
You have to lower your position size to stay within your predetermined risk tolerances (how much money you’re willing to lose on this trade). And that tends to hurt your potential profits if you’re right and the trade ends up winning.
Trading is a fine art of balancing the probability of winning and risk/reward ratios.
One way to combat this problem is by altering where you enter the trade. So instead of entering the above support in our example, you enter where your stop would typically be. Remember the joke?
Don’t neglect the mental side of things.
Some can stand to sit on our hands and not get any trades for a long time; others cannot. Some can take a lot of losses all the time and not blink an eyelid; others end up under their blankets after a few failed attempts.
Know yourself and adapt your strategies accordingly!
The most important point is to never allow your losses to grow large.
Keep them small in any way you know how to. If your system is solid and you have an actual EDGE in the market, your winners will ultimately take care of the losers. You will have to endure losses, so you had better make friends with them!
Check the article to see some examples, problems, and benefits of alternative stop-loss placement.
Chapter 9:
Alternative Risk Management Strategies to Using Hard Stops on Charts
Hard-stop loss orders aren’t the only way to manage risk. How you manage risk is irrelevant as long as you always protect your capital!
Read the complete article on alternative risk management strategies.
What is this chapter and the article about:
- Alternative strategies for trade exits without using stop losses.
- Trading based on intuition and fundamentals instead of technical analysis.
- Trade exit criteria based on news and events.
- Aligning trade exit strategies with trade entry reasons.
- Position sizing techniques for risk management in trading.
- Setting up trading rules for risk management.
- Diversification and hedging strategies in cryptocurrency.
- Using time stops to manage trades.
- Crypto trading without traditional stop losses
- Balancing risk and reward in trading.
What if chart-based stop losses aren’t for you? What if you’ve decided that hard stops are just a convenient way to throw money out the window? Death by a thousand cuts is still death, I agree.
Some of you may find looking at the charts useless and don’t make your trading decision based on charts. Regarding trading, various factors such as intuition, insider knowledge, market fundamentals, other people’s opinions, or current events could influence your decisions. The possibilities are endless.
For you, then, looking at the charts and managing risk based on them isn’t really an option. But you must still protect your capital somehow!
Have you considered using time stops?
Time stops are trade exits based on the length of time a trade has been open.
In simple terms — if the price doesn’t do X in Y amount of time, I will close the trade manually.
Something is wrong when you trade on a 1-minute time frame, and nothing happens for hours. There are forces at play you did not account for. Get out. If nothing else, you’re losing money on opportunity cost alone.
The same can be applied to larger time frames. If you trade on 4-hour candles and you’ve been in a trade for a week without any real movement, you might need to reconsider the trading idea.
You will need plenty of experience behind your belt to determine what is too much time in one trade for your personal trading style and time frame.
You can use anything as a stop trigger — prompting you to exit the trade.
If you decide to trade based on news and the market doesn’t react as expected, it’s best to exit the trade immediately. I avoid trading the news as it often leads to a sell-off. “Buy the rumor, sell the news.”
If your trading entry is based on specific information or factors, the same should apply to your exit. Use the same exit approach and criteria as you use for the entry. Sounds logical, doesn’t it?
Don’t get attached to your trades!
Whatever you do, don’t fall into complacency and the need to keep a trade open once the reason for opening the trade in the first place has disappeared.
Traders often look toward other indicators, correlations, and opinions to justify refusing to close a position, especially when they would have to take a loss. If you do that, you’re not trading your system; you’re denying reality and prolonging the inevitable on hope, which will only get you into trouble.
What if you don’t have a system to your madness and can’t define your trades?
Here’s a simple metric for all such examples: When in doubt, get the hell out! Cut mercilessly. Cut immediately. Be the first passenger to jump off the sinking ship and ensure your survival.
If you don’t have a hard stop loss, positing sizing is crucial!
In trading and investing strategies, where placing a stop loss is impossible or problematic, there is only one solution — cutting down on your size.
Trade smaller. Enter the trade with only a small percentage of your available portfolio and cut it or add to the position, depending on what happens next.
Set up rules regarding your trading strategy and risk management.
Determine upfront how much you are willing to risk on any trade and calculate your maximum position size. And most importantly, follow those rules to the letter!
Even if you don’t trade systematically, you should still know the reasons for entering your trade, the expected target, and when you’ll be proven wrong on your trading idea.
Chapter 10:
Don’t Like Using a Stop Loss? Here’s a Quick Guide to Hedging
You can manage risk in a multitude of ways, one of which is by hedging your investments. Here’s everything you need to know about hedging.
Read the full article on using hedging as a risk management tool.
What is this chapter and the article about:
- What is hedging in finance and investments?
- How can I hedge my investments to manage risk?
- Hedging strategies for Bitcoin and cryptocurrencies.
- What is short selling, and how is it used as a hedge?
- How does hedging work in volatile markets like Bitcoin?
- Using leverage for hedging — pros and cons.
- Hedging with uncorrelated assets for risk management.
- When should I consider hedging my investment?
- Is hedging a good strategy for protecting my portfolio?
- Hedging vs. stop loss — which is better for risk management?
- Risks and benefits of hedging investments.
- Why is timing important in hedging investments?
- Hedging for beginners — where should I start?
What does it mean to hedge your position?
“To hedge, in finance, is to take an offsetting position in an asset or investment that reduces the price risk of an existing position. A hedge is, therefore, a trade that is made with the purpose of reducing the risk of adverse price movements in another asset. Normally, a hedge consists of taking the opposite position in a related security or in a derivative security based on the asset to be hedged.” Investopedia
How do you hedge in practice?
Since this is a Bitcoin-focused publication, we’ll concentrate on learning to hedge your Bitcoin investments.
Imagine a scenario where you buy one Bitcoin intending to hold it for a few years or decades. You believe the price is destined to go up in the long term, but you are also an intelligent investor and realize that:
- Nothing is certain in this world.
- Anything can happen at any time.
- You must always manage risk and protect your money.
- Bitcoin is a volatile asset that regularly drops by 50–70%.
- There is a non-zero chance that something unexpected happens, and it goes to zero.
Step number one — the buy.
First, you have to purchase one Bitcoin. The same goes for any other asset, the lesson is universal, and this is just an example.
You create an account on an exchange, wire your money, and buy one Bitcoin. You are now a proud owner of Bitcoin, a true visionary investor, and one of the cool kids.
Step number two — choose your hedge.
There are generally two different hedging systems we can use:
- We can open a short position on our asset, selling an equal amount of Bitcoin (in our case) while still holding on to our core investment.
- We can buy an asset with the tendency or design to go in the other direction than our invested asset. If one goes up, the other goes down. We buy equal amounts, and we are hedged.
Using short selling as a hedge system.
Once you have your Bitcoin, you can keep it on the exchange (not recommended) or transfer it onto your wallet, preferably a paper or hard wallet.
- Keeping your Bitcoin on the exchange simplifies hedging but exposes you to third-party risk.
- Transferring your assets to your wallet, while smarter and safer, does complicate things considerably and requires some math.
Complete or partial hedge.
You don’t have to hedge one for one, so if you bought one Bitcoin, you open a short position of one Bitcoin. Instead, You can open a partial hedge for 10%, 30%, or 50%.
- That ensures that you are managing risk and will take less of a hit if the price of your investment plummets.
- If, on the other hand, the price rises, you’ll be losing money, but in limited quantities, as you have only partially hedged.
Hedging by buying an uncorrelated asset.
In simple terms, this could be deemed diversification, but it must be done with genuinely uncorrelated assets. Ideally, for hedging, assets that go in the opposite direction price-wise. When one goes up, the other falls. There are some additional dangers in this approach. Read the article for more information.
When does hedging your investments make sense?
In reality, our hedges must be well-timed and flexible. We must be quick to protect our investments in a downturn and make money when the price goes up.
- In practice, one should hedge their investment at the first sign of trouble in the market, ideally before we enter a bear trend or a deep correction.
- Alternatively, one could build a hedge as the price goes up, near the expected top of the bull trend.
But here’s the thing with timing. We all want to do it, but most fail miserably. Timing the market is challenging.
Hedging should be used seldom and carefully. It’s not as straightforward as using a stop loss or proper position sizing and can end up biting us in the ass.
CONGRATULATIONS!
You’ve made it across this monster of an informative article. I hope you learned something new and are now armed with new ideas, strategies, and tools for managing risk while trading or investing.
Remember, this article is only a summary of the most important posts I’ve written about risk management. Study and apply the lessons. Think of it as a holy grail of trading and cryptocurrency risk management.
Stay safe out there, and remember to always manage risk!
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