Risk management in cryptocurrency trading

Risk management in cryptocurrency trading

High risks level is one of the main characteristics of the cryptocurrency market. Many traders leave this marketplace because of the fear of losing. In this article, we will look at the basic rules that risk management in cryptocurrency, as well as figure out how to control risks in trading.

If you want to be a successful trader, you must learn to assess risks, balance and reduce them. Only in this case, the capital will not be just saved, but also multiplied.

What is risk management?

Risk management is a strategy that aims to reduce your losses in transactions. Risk management answers the question — how much can I lose in a deal?

Types of risks:

* market risk — the risk of adverse changes in the value of the asset;

* credit risk is the risk of default on payment obligations undertaken by it;

* liquidity risk — the risk of the inability to convert the entire position volume into fiduciary currency (or equivalents) at the best prices;

* operational risk — the risk of being faced with the inability to make trades or deposit / withdrawal of assets.

These and many other risks affect the operation and stability of crypto markets and its individual participants. When a financial institution or a corporation does not fulfill its obligations, it receives losses from transactions with financial assets or in operating activities, this negatively affects the prices of the respective assets.

In fact, there is a huge number of various classifications of risks, depended of their accounting and management in various economic areas. For example, in the field of banking supervision, the most comprehensive regulatory document, including risk management, is called Basel III.

It is possible that by the time, these guidelines will be developed for the crypto industry too.

Basic principles of risk management:

1. The first thing a trader should do in investing is to count such amount of money that he can completely lose. Psychologically, this mark is at 10% of monthly income. If you plan to continue to engage in this kind of activity professionally, then in no case do you trade on borrowed money taken from relatives, friends or banks. To margin trading should be approached with the utmost caution, since in this case, the extraction of potentially high profits carries significant risk.

And here we come to the basic and quite logical principle:

Risk ↑ Profit

Risk and profit are directly related to each other. In other words, the increased risk should bring high profits, and vice versa. The conclusion from this simple principle is also quite obvious: if we take an excessive risk to earn as much (or even less), then such an investment should be abandoned.

2. Diversification of investments. We are talking about the skills to create a balanced investment portfolio. However, before its formation, diversification should begin with a reduction in operational risks. The distribution of available capital among several trading platforms will reduce potential losses due to hacking or closing one of them.

In trading, this is expressed in the form of a correct calculation of the position being opened, and is also closely related to the capital management model as a whole (with money management). A limiting case and a common mistake for many newbies is to risk 100% of the capital on a single trade / position. It is not necessary to put all the eggs in one basket — this saying perfectly describes a similar situation.

In both cases, it all comes down to determining the maximum permissible risk for each individual operation.

3. The rules are 2% and 6% from A. Elder. Limit the risks per session. Standard recommendations on risk management are found in many trading books. One quite popular risk management methodology was described in his works by Alexander Elder. It can and should be applied at the initial stage, until its own system of determining risks in trade is formed.

“Sharks” in trade and the rule of 2%. The beginner’s error described above with the risk of losing 100% of the funds is of the variety — the investor risks 30–50% of the deposit at the moment and more. Elder called such a situation “the risk of being eaten by a shark” when, as a result of several large losses, capital could be zero. To protect investments from this risk, the size of one position should not exceed 2% of the available funds. This is the “two percent rule”.

“Piranhas” in trade and the rule of 6%. Sometimes it happens that a trader for one reason or another (more often psychological) cannot stop a series of unprofitable transactions, which Elder compared with a flock of predatory piranhas, who grab the prey in pieces. If there are many such transactions, then the capital will be in the high risk zone. The rule of 6% limits the maximum used share of funds in the trading moment. In other words, it sets the maximum permissible risk per session. If the loss of capital was more than 6% — it is necessary to stop trading for some time (Helder recommends 1–2 weeks). Firstly, to analyze the situation, secondly, in order to avoid psychological errors.

Thus, Elder recommends at the same time opening no more than three transactions, with each limiting to two percent of the capital. Of course, these rules can be modified over time to suit your own trading strategy, change the percentage and time spent on the analysis, however, the general concept is recommended to remain in its original form.

4. The correct calculation of the position. It is necessary to take the rule of counting all as a percentage Risk can be described as the likelihood of an adverse outcome. Also under the risk refers to the level of possible financial loss. Thus, risk is a two-dimensional value characterizing the probability and amount of losses (of total capital). All of these values ​​are measured in percent. While you calculating it is very important to take into account the various commissions on crypto. They may be as follows: - transfer of funds, deposit and withdrawal; - opening a position (and closing with another position); - for the use of margin leverage (percentage of landing or swaps), etc.

5. Position management. To manage positions, you must use pending orders Stop loss (SL) and Take profit (TP). Look at the value:

C = A / B


C — the ratio of profit to loss;

A — is the profit when the TP order is triggered;

B — loss when a SL order is triggered.

In the trading literature, it is often recommended to use trading strategies and entry points with a calculated value of C from 2 to 3. In other words, the potential profit from a transaction must exceed the potential loss several times.

Some traders do not use SL in trading, preferring to “sit out” the drawdown. This complicates risk control (the fall may continue). Especially not to do so in the margin trading. All beginners are strongly advised to use SL to trade using leverage.

Below is a table illustrating the percentage of capital gains needed to break even with different amounts of losses:

Capital loss/Percentage required for restoring the previous amount of the deposit’s

As can be seen from the table, managing the size of the position plays a key role — the more the loss is fixed by the trader, the harder it is for him to recover the first amount of trading capital.

For example, a deposit of $ 1000 after a series of losing trades turned into $ 100. Now, to return the original amount of capital, the trader needs to increase the amount of $ 100 by 900%.

Without competent risk management, trading on the stock exchange turns into something like a game in a casino.

6. Calculation of the position using the Kelly Formula

Many investors in risk management use the Kelly formula. It serves to determine the maximum allowable percentage of capital that can be used for an operation.

The percentage of capital is calculated by the formula:

f = x / k


x — the amount of the transaction / transaction;

K — the amount of available capital.

The Kelly formula defines the limit value of f:


p — is the probability of a positive outcome for a trading strategy;

A — is the profit when the TP order is triggered;

B — loss, when the SL order is triggered;

g — leverage used (equal to 1 if the shoulder is not used).

It is not recommended to use the maximum values of fmax calculated by the Kelly formula.

The optimal range to reduce the estimated risks:

At this stage, there is an additional risk associated with the incorrect counting of probability.

Work with probability

There are several different approaches to determining the likelihood of a positive investment outcome:

- if the source of forecasting is external, then as a guide you can take the average percentage of successful signals. However, it should be borne in mind that, for example, numerous groups / chats in instant messengers (mainly in Telegram) can distort real statistics;

- if a trader / investor independently applies a trading strategy, keeps records of transactions and has reliable and complete statistical data (or has the opportunity to test his strategy on history), then:


p — is the probability of a positive outcome for a trading strategy / conversion of positive transactions;

M — the number of profitable transactions;

N is the total number of deals by strategy.

You should understand that in any case, the data of the trade diary (statement) will not give a static result — errors and spread of values will always accompany. When working with historical data there is always the risk of a change in market conditions, which leads to a decrease in the effectiveness of the strategy in the future.


As we said at the beginning of the special project, there are risks in any financial transactions. And the main task of the investor is not to reject risk in general, but to make a decision — what is the point to take this risk.

For any type of investment, it is necessary to be able to determine risks in advance. In other words, it should be understood what potential profit we expect and what loss we are ready to take. Also, all the above recommendations will not produce results without a systematic trading, which implies accounting, calculation and analysis of all positions opened.

A successful trader is not the one who made millions, but the one who did not to lose and stayed on the market.

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