Risk management in crypto trading
In cryptocurrency trading, having a winning strategy isn’t enough; without proper risk management, success remains elusive. While many traders attribute their losses to flaws in their trading strategy, the reality often stems from inadequate risk management.
Why is risk management crucial? It’s the differentiator between successful and unsuccessful traders. While many focus on profit generation, few prioritize protecting their capital. Though market outcomes are unpredictable, effective risk management mitigates potential losses and fosters long-term profitability.
An effective risk management:
In cryptocurrency trading, a prop trading firm like Bitfunded can offer great financial opportunities, but it also demands stricter risk management in return. To succeed, funded traders must identify the two key areas that define the risk of their operations: their Risk-Reward Ratio and the calculation of their Drawdown.
1) Risk-Reward Ratio:
The Risk-Reward Ratio (RR) refers to the relationship between potential losses and gains in a given trade. This is calculated by comparing the difference between the entry price (base), the stop-loss, and the take-profit price. For example, a trade with a RR of 1:5 suggests that the trader will risk 1 USDT to have the opportunity to earn 5 USDT. Conversely, a RR of 1:3 suggests risking 1 USDT to potentially earn 3 USDT.
For example, a trader who is right 50% of the time but has a RR of 1:1 may not be profitable. However, a trader with a RR of 1:5 can be profitable with a success rate of only 20%. As a trader, you can analyze the RR of your operations before taking a trade to evaluate if it statistically worth taking
2) Drawdowns
Every novice trader tries to avoid the possibility of losing in trading, but the reality is that losses are inevitable, and we must be well prepared for them. If you have a strategy with a 60% probability success rate, there is still a 70% probability that you may have four consecutive trades heading straight towards your stop-loss.
Since it is statistically viable, at this point you should ask yourself: “Am I able to withstand 4 consecutive losing trades?” Based on your answer, you should adjust or maintain your Risk-Reward strategy and the amount of capital risked per trade. This is something you must keep in mind in your trading plan.
How to improve your risk management?
⚖️ Calculate your risks: Never risk more than you can afford to lose and always try to maintain a favorable Risk-Reward ratio. Determine the appropriate amount to invest in each operation and set profit targets that exceed your potential losses.
🤔 Understand your emotions, but do not follow them: Maintaining emotional discipline is crucial in the world of crypto trading. Acting impulsively outside of your trading plan based solely on sudden price movements that generate FOMO or FUD among inexperienced traders can result in exposure to uncalculated risk.
🔎 Keep track of what’s happening: It may seem repetitive, but staying updated on news affecting the performance of traditional markets and cryptos can be one of the best ways to manage your current risk with the market. Understanding market trends, upcoming events, and potential price movements can help you make more informed decisions.
✍️ Maintain a post-trading routine: These are the actions you must take after taking or closing a trade (regardless of its outcome). The goal of this routine is to detail the actions that will help: better understand your strategy, correct mistakes, increase your efficiency, avoid future stop-losses, and achieve better results.