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.
If you're invested in security and certainty, you are on the wrong planet." Pema Chödrön
While the above quote wasn’t meant for traders, it very much still applies. There is no security and certainty anywhere in this game. None whatsoever! If you have any hope to survive for a long period of time, you had better make peace with this fact and adjust your mentality. The alternative is certain doom in one form or another.
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.
In this series, I will attempt to point out some of the risks you might encounter playing with cryptocurrencies and trading in general and how best to protect yourself from them. But be warned, there are some risks you simply cannot escape and have to accept as fact, working around them as best as you can.
Control what you can. Let go of the rest!
That’s the motto I try to live my life by, often failing miserably and ending in a sea of self-inflicted torment and anxiety. For your own sanity and health, be better, do better. 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. There are, however, numerous outside forces you have absolutely no control over. That’s why it's called managing risk, not eliminating risk.
Here’s a real-world example as an illustration - riding motorcycles.
I’m in love with motorcycles and always have been. Even worse, I absolutely love traveling with motorcycles, adding a myriad of unknowns to the already hazardous activity. Next to my family, it’s what I live for. And yes, we all know motorcycles are dangerous, there is no denying that. And while I’ve been riding for almost 25 years now with zero serious incidents (knocking on wood), my “winning streak” could end at any moment. That is a fact! One I have to accept every time I start my bike up and leave home.
So first thing one has to do is identify all the inherent dangers that prey upon every biker as he embarks on the road. There are thousands of ways you can get hurt riding a motorcycle. Sometimes it does indeed seem like everything and everybody is out to get you. But knowing this, you can still mitigate that risk to a high degree, although you can never eliminate it entirely.
So what is in my control as a motorcyclist?
First, I can be aware of the fact that danger lies behind every corner, car, building, crossroad… I have to acknowledge that a certain amount of people simply will not see me on the road. It’s not an IF, but a WHEN and how many times on each ride.
Knowing this, smart riders simply assume that every car, truck, and bus driver is out to kill them and incorporate that into their riding. What does this seemingly irrational thesis mean in practice?
Simply this - whenever you drive past or near another vehicle on the road, you assume that he will react in the worst possible way, he will not see you and cut you off, he won’t indicate a change in direction and will drive right into you, he will open his doors when standing still, he will misjudge your speed, he will run the red light, he doesn’t know it’s your right of passage and so on. Get the picture?
So what I do is I simply prepare and watch out for those worst-case scenario situations all the time, adjusting my speed and behavior. It doesn’t matter if I had the right of way if I ended up a bloody ornament on some truck’s grill, now does it?
What else is in my power?
To always check that my motorcycle is technically flawless.
To always wear full protective gear.
To slow the fuck down in most situations.
To always add a little more safety margin in my riding through curves. My personal estimate is that between 10 and 20% of my absolute capability stays “on the bench,” no matter what, on public roads. Enough to have the option of reacting to most surprises on the road, never going all out.
Yes, that means less fun (profit?), but it also means I get to hopefully do this for another 25 years (survive).
A trade I’ve decided upon and accepted a long time ago. What else is in my power?
I can continually improve my riding skills through training and practice.
I can stay in good condition and healthy, never riding if I feel “off.”
I can wear some reflective clothes to make myself more visible.
I stay focused on the road at all times, and if I feel my concentration diminishing, I stop and rest.
In order to avoid having to play chicken with some unsuspecting deer, I avoid riding at dusk or at night, and so on.
Do everything that is in your power, and then let go of the rest.
Which brings me to the inevitable question - why ride a motorcycle then, if it’s so dangerous? And the same can be said for trading, investing, climbing, swimming, dating (hehe), or any other non-necessary activity in one’s life.
Because the biggest risk in one’s life is to take no risk in the first place!
A life without taking any risks is no life at all.
I would venture so far as to say it’s merely waiting to die. You risk getting hurt, in one form or another, in anything you do that is outside your comfort zone, that is new to you, that is reaching higher for what you desire, basically. That goes for trading and investing as well.
If you risk something and try, you can either make it or you can fail. But if you never even take that first step, to try, to risk something, you are guaranteed to never make it, making your dreams effectively an impossibility.
You know the alternative, a job, hopefully a pension, a boss, inflation eating away at anything you manage to save, and so on. The choice is, of course, yours and yours alone. I suspect you might be more like me since you find yourself in this neck of the woods. Willing to try, willing to risk something in order to live a better life, to live the life you want, on your terms.
What is your why?
We all have our reasons for getting into the game or trading or investing. I believe it’s important that you know yours.
Define them carefully. And identify what you’re willing to sacrifice in order to become who or what you wish to become. Because a price will definitely be paid, so it’s better to decide on that upfront.
For me, this was never about getting rich, sports cars, mansions, status, or pool parties. I am a simple man, a family man, a minimalistic man. But I have one personality flaw that has plagued me my entire life. I despise authority, I hate being told what to do, I hate rules, and I hate conformity. And when I say hate, I mean I am revolted by it. Even as a small kid, I always refused to call my parents by “mom” and “dad” and called them by their names, just to somehow hammer in my independence and sovereignty (of which I had none, of course).
The idea of an office job, which I’ve had the unfortunate pleasure of experiencing for most of my life, is a hellscape for me. A prison. A dark, suffocating cell that drains me of my life, one miserable day at a time. I can’t sleep as I am plagued by workplace-related nightmares (no joke), and I have never, ever felt sufficiently compensated for my time. The only currency that can never be replaced. One we all have so little of at our disposal.
Having said that, I did give it a fair shot, but it nearly killed me (literally), so I now see the world from a different perspective. I value time, love, and freedom above all else. I’ve made peace with my mortality but walked out of the fire a different man, a new man. And I am paying a price for that.
A price too high for most people’s comfort. So my reason for playing in this sandbox, for learning, trying, and always getting back up after I’ve fallen, is freedom. Freedom to spend my days as I choose to. Freedom from authority. Freedom to travel. Freedom to spend time with my family. And since I wasn't born with a silver spoon up my ass, the price is paid by walking the harder road, a road of financial struggle, discomfort, insecurity, and uncertainty, all in exchange for a dream and an abundance of time.
What price are you willing to pay?
When you know your “WHY” and you know what “PRICE” you’re willing to pay, we can move on to the next step. Determining your RISK TOLERANCE.
There are people out there who are comfortable with risk, any risk, even risk of ruin. All-or-nothing types. I’ve known a few. I love these wild spirits, but could never really relate. My risk tolerance, for example, is minimal. Of course, saying that my risk tolerance is minimal that only relates to the crowd of traders, investors, and cryptocurrency enthusiasts. For the “normal people,” I am the crazy risk taker who sold everything he had in order to learn trading, who refuses to conform to having a normal job and a safe salary, pension, and all else that comes with the safe, normal route.
But as a trader, I truly 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. And I know for a fact that I was both an idiot “can’t happen to me” biker and an idiot “know it all” trader before my christening.
So yeah, if you’re only now getting into this game or have been here only for a short time, please wear a helmet. Your time is coming. There will be surprises in the market. There will be pain, and there will be sorrow. But that’s just a part of this game. Don’t be like a fighter, never expecting to get punched in the face.
If you can’t handle losses or are completely unprepared to take on risk, accepting that there is no certainty in this market, you might want to stick to your safe job. There is nothing wrong with that, and the market will eat you up.
Still here? I didn’t scare you?
All right, so what is your risk tolerance?
Take account of all of your financial possessions and determine how much money you are willing to risk in the markets. Notice I said risk, not lose, but the old saying is still golden.
Never risk more money than you’re willing to lose.
I took that one way too lightly, thinking I’ll be able to stop losses in time, myself." “I’ll never take the full hit. My strategy works 95% of the time. That can’t happen to me. That rule is for idiots with no self-control.” Yeah, I ended up being that idiot. Not once, not twice… but enough about me, hehe.
When looking for your number, how much you’re willing to lose, at least in the beginning, stay on the bottom side of your tolerance. Because the pain of being heavily underwater or even actually losing a lot of money is real, and it can damage you for years. Financially and mentally. Never underestimate the latter.
Now, if you’re relatively well off, you might not struggle with this point. Like if you have a million tucked away somewhere, a good-paying job, and you just want to play with a small portion of your wealth (up to 10%), you’re a blessed man or a woman. It doesn’t get much better than that. You’ve got everything covered.
You have a trading independent way of paying your bills (so, so important), you have a considerable safety net and “try again” cushion (peace of mind), and just about enough money, where you will feel that your trading profits are actually making a difference, while even the worst case scenario loss won’t mean total ruin for you. Most of us, however, are not so lucky.
I will reiterate this point again and then shut up about it because I don’t want to be a hypocrite.
If you have a job for the love of God, keep it!
You cannot understand what an advantage that will be for you mentally in this game of trading. And how damaging the pressure of having to pay your bills from trading alone can be.
Not to mention how hard it is to be consistently profitable and be able to take money off the table every single month. It’s almost impossible, especially in the beginning, and if your portfolio isn’t one of significant size. Yes, your growth and learning will be a bit slower, but your mind will be in the best position possible, and you will be able to grow your portfolio uninterrupted. Think compounding!
To illustrate this point, let's think of an imaginary newby who is definitely not me, who only has 10,000 USD to start with, and just quit his intolerable job to go all in on trading. This person, let’s call him Brendon, also has bills to pay in the amount of 1,000 USD per month. In essence, this means that he has 10 months’ worth of living expenses tucked away, but they are not safe. That money is now his trading portfolio.
So in order just to keep his portfolio size, he needs to make 10% plus fees every month, without exception. In order to grow it, he now has to basically be as good as the best traders in the world. Yes, and he’s just a newbie with a dream. Good luck, Brandon!
I think you can already see what an impossible situation that young man has put himself into. Now let’s say that he starts off with a bit of luck and manages to run his portfolio up to 50,000 USD. Now he’s a confident little cock, isn’t he? “I shall never work again in my life,” he is overheard exclaiming to his peers. “I make more in a month trading than I did in two years of working at my job,” he likes to add. This might all be true for this imaginary Brandon fella, and good for him.
But he has yet to meet the other side of the coin. A proper bear market, for instance.
He may even have been smart enough to take some of these profits out of the game and set them aside for monthly expenses and some trips. Bravo Brandon, bravo. Alas, it was not enough. He made a few bad trades and met a few never-before-seen market conditions, giving most of his portfolio back to the Gods of fortune. He’s now back where he started, which is OK, he lies to himself. At least he didn’t really lose any money, he explains to his disapproving parents. But the bear market is still showing its teeth a year later, and he has had to spend most of his portfolio just to cover his expenses.
Nowadays, in order to simply pay his bills and keep the same portfolio size, he has to become the best trader that ever lived in the history of time, making what is between 50 and 100% every month, without fail. In a bear market, with zero liquidity and volatility, no less. I guess you can already tell where this story is going and where our Brandon ended up, can’t you?
Don’t be like Brandon, is what I’m saying. The markets are hard enough. There’s no need to play this game on an extra hard level.
How much money are you willing to lose?
In any case, to close this up, 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.
If you wanted to be conservative, especially in the beginning, I would advise you to risk up to 10% of your liquid financial stack on trading (the whole trading portfolio, not risk per trade), although I am fully aware that if you don’t have much, that will seem pointless to you. I get it. Only you can assess what the right number is for you, depending on your personal and financial situation. But 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”!
And then, I would spread that up, depending on the actual size of your portfolio, between different exchanges mitigating third-party risk. As I write this post, the market is going through a tsunami of worst possible news, heavy liquidations, and the fall of what was, until recently, the second biggest crypto exchange FTX.
Many experienced and wealthy traders got caught with their pants down and their cheeks spread wide open on this one. The way things are looking right now, they might never see their money again. They are properly fucked!
We are all susceptible to greed and to making mistakes, so we must protect ourselves with tight money-managing rules because greed conquers even the strongest of us.
After you’ve done all that, we can start to discuss your chosen strategies, markets, tactics, and goals, where we must determine how much you are willing to risk/lose on every single trade. And then it is up to you to abide by your own rules. Otherwise, we’re just wasting time here.
Remember - control what you can control. In trading, you don’t really control all that much, and where the execution is concerned, you mostly control only the amount of money you are willing to lose and the point at which you are willing to take that loss. If you have good risk management, of course. Otherwise, you’re simply a little fish in a big pond full of hungry sharks with more money, knowledge, and information than you. You’re dinner, basically.
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 hard about what I’ve written. Make a plan. Know your “why”. Know how much you’re willing to risk in the markets and write it all down. 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.
In this series, I’ll be focusing on the most prevalent dangers and risks every trader faces in the markets and what you can do to mitigate them. You can expect to see a post on this topic every month for the foreseeable future. So subscribe to this newsletter and follow along. This series will be absolutely free forever. Stay safe out there.
If you’re interested in learning more about risk management in trading, start here:
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!
Alternative Risk Management Strategies to Using Hard Stops on Charts
Don't Like Using a Stop Loss? Here's a Quick Guide to Hedging
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