Welcome to this first episode of Wall Street Cubs on the Journal du Coin! This regular column will teach you the basics of cryptocurrency trading, or refresh your memory for the more experienced.
Everything needs a start – Qhen beginners arrive in the crypto ecosystem and want to get into trading, they tend to miss out on learning about risk management. This element is however essential for any stakeholder wishing to be a winner in the long term. Let’s take a look at the basics of risk management, which, if you are rigorous, will ensure your survival in this market.
The Cub Scouts chronicle is brought to you in collaboration with the Coin Trading and its algorithmic trading solution finally accessible to individuals.
Crypto trading: Why manage your risk?
First of all, I would like us to ask ourselves the question “why manage our risk?”. And yes, finally, we could simply buy and wait (the famous HODL), this logic is understandable if we position ourselves in time as an investor. But for anyone who is in a “trading” logic, the objective will be above all to take advantage of movements in the short – medium term in order to speculate.
Remember that as a beginner, your primary goal should be the survival. Making profits will be the second step, not losing half of your capital on 4 trades, that’s the priority.
Most beginners will focus first on technical analysis and the resulting strategies. You’ll find hundreds of them on YouTube, so is it that easy to beat the market? Of course not.
No strategy is 100% winning.
We must therefore gauge, using different elements, our ability to absorb losses while ensuring our survival.
Risk management: the basics.
The pillars of a trader, which make him last and prosper over the long term, are the RR (Risk-Reward Ratio) as well as the risk per trade.
The Risk-Reward Ratio
The risk-reward ratio is fundamental in trading, it is the guideline of your risk aversion.
We will assume, throughout this article, that you start with a capital of $1000.
Let’s imagine that you decide to take a trade on Bitcoin, with an RR (Ratio Risk Reward) of 1:2. What it means in practice, what you can win twice as much as you stand to lose.
On this trade, I placed my Stop Loss as well as my Take Profit, so that I risk 2x less than I can win. You can choose to have a RR of 1:2, 1:3, 1:30… you just have to be profitable depending on the success rate of your strategy.
It can be flexible too. But then why is it so important? You will understand better with this table.
- If you have a risk reward ratio of 1:1, you will need to succeed more than 50% of your trades in order to be profitable.
- If you have a risk-to-reward ratio of 1:2, you will need to win more than 33% of your trades in order to be profitable.
- From 1:5, it will only take 17% of winning trade to be profitable.
You now understand the importance of the RR ratio. Depending on your strategy and its success rate, you will have to adjust the latter.
The risk per trade.
A pretty simple rule on this: your trades should never make you risk more than 1% to 5% of your capital. 5% is already quite high, for my part, I stick to the 2% max loss. But this rule is quite flexible depending on your type of trading. Let me explain :
- If you make 2-3 trades per month, swing trading (position from several days to several weeks) it seems irrelevant to expose yourself to only 1% risk, you can go up to 5-7% risk without worry.
- If you are a scalperwhich can take up to several dozen trades in the day, a risk of 0.5-1% seems more consistent, because if you miss a few trades, your capital can quickly suffer.
To know what type of trading you want to practice, you must first know yourself, know your desires, what you expect from trading, the time you want to devote to it…
“The risk comes from not knowing what you are doing. »
Test your strategy
Now let’s start from a premise: your strategy wins you 40% of the time, with a RR of 2:1, and you choose not to risk +2% of your capital. We leave as planned with $1000 in capital.
Based on 100 trades, your strategy should bring you about +50% gains, in any case, this is the average of these 5 tests.
Let’s now assume that your trades are made in RR 5:1, and that you only succeed in 20% of your trades, out of 100 trades, 80 would therefore have hit their stop loss. We still keep our 2% risk.
We can see that on average we would be profitable after 100 trades.
So you clearly understand the importance of risk management in your strategy. Trading is a marathon and not a sprint, your main goal is survival, so this data is very important.
To do your tests according to your strategy, you can use this site.
Now that we’ve seen the basics of risk management together, let’s talk about the controversial leverage effect.
What is leverage?
Leverage allows you to take on debt in order to increase your position size. Concrete example :
A Bitcoin is worth $50,000, you have a capital of $1000.
In order to take control of a Bitcoin, we therefore need 50 times the capital actually available. One can take control of this Bitcoin for $1000 with leverage 50.
The mechanics are quite simple. If bitcoin gains 1%, you will make +50%. Conversely, if Bitcoin loses 1%, you will lose 50%. Easy, right?
I often see speakers say on the networks that leverage is obligatorily a trap and dangerous.
Indeed, this tool is dangerous, if like most stakeholders, you do not master risk management. If you are informed, and your risk management is rigorous, the leverage effect will change absolutely nothing in your trading.
Be careful all the same with certain things with the latter, a trading plan must be defined in advance, with your entry and your exit points, and you must stick to it. To trade with leverage without a trading plan is to expose yourself to infinite risk.
” Don’t be arrogant otherwise you will ignore your risk management. The best traders are the most humble. »
The cryptocurrency market is far too volatile to hope to intervene if a leverage 10 trade does not go your way and you have no Stop Loss. We will come back to how to develop a trading plan in a future article, so do not hesitate to follow us on our various networks to be kept informed!
Use leverage wisely.
You have to use the lever if it is pertinent. Let me explain :
→ On a swing (position of several days to several weeks) which can earn you up to 40-50-60% is it relevant to do it in leverage 10?
→ On a scalping (position of a few minutes) which will bring you back 1-1.5%, unless you have a large enough capital, it will probably be unprofitable to do it without leverage or with low leverage.
Once again everything will be a question of your personal type of trading, of knowing yourself, because the leverage effect increases volatility by extension, so you also have to manage this pressure.
Risk management is the first brick of your trading adventure. It provides certainty in an uncertain market: not to go bankrupt. It will not be essential for all profiles, especially those who invest in large caps for the very long term! But it will certainly allow you to find serenity with your investments.
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