Risk Management

Capital Buckets

• Divide your capital into different “buckets”. For example, you can have a cold storage or hodl bucket which you don't plan on selling.
• You can have a bucket for the capital you use for trading the Bitcoin cycle.
• And you can have a bucket for altcoin trading during a bull trend.
• Each of these buckets has a different time horizon, risk tolerance, and position size. Don't use your hodl/cold storage bucket to make a day trade.

Psychological Biases

Confirmation Bias

• Confirmation bias is the tendency to seek out or interpret information in a way that confirms your pre-existing beliefs, while ignoring or discounting evidence that contradicts them.
• A trader might only focus on news or data that supports their current market view, ignoring signs that suggest they may be wrong.

Hindsight Bias

• Hindsight bias is the tendency to believe, after an event has occurred, that it was predictable all along, even though there was no objective way to foresee it.
• After a market movement, traders may believe they “knew” it was going to happen, even if there was no clear signal beforehand.

Outcome Bias

• Outcome bias is the tendency to judge the quality of a decision based on its outcome, rather than on the information and reasoning that was used to make the decision.
• A trader might believe that a poorly informed trade was a good decision simply because it resulted in a profit. Conversely, they may consider a well-reasoned trade to be a bad decision if it resulted in a loss.

Set Stop Losses

• Predefine an exit point (stop loss) where you will take action to prevent further losses.
• It limits potential losses and protects capital in case the market moves against you. Stop losses help enforce discipline in sticking to your risk strategy.
• You don't have to necessarily set a hard stop loss which automatically sells your position. You can also set an alarm before your stop loss, and if it gets triggered you can assess the current situation and if nothing changed with your thesis you can close the position manually.

Risk-Reward Ratio

The risk to reward ratio is a concept in trading that helps to evaluate the potential profit of a trade relative to its potential loss. It is a critical tool for managing risk and ensuring that the potential reward of a trade justifies the risk being taken.

• A common practice is to maintain a risk-reward ratio of at least 1:2, meaning you should aim to make at least twice as much as you're risking on a trade.
• In order to set your potential profit and loss, you have to do your technical analysis.
• Calculating Risk to Reward: The ratio is calculated by dividing the potential profit by the potential loss. For example, if a trader risks $100 to potentially make $300, the risk to reward ratio is 1:3. This means that for every dollar you risk, you expect to make three dollars in return.

Calculating Position Size

1. 1. Determine Your Risk Tolerance
   • First, decide how much of your portfolio you are willing to risk on a single trade. This is typically expressed as a dollar amount or a percentage of your total portfolio. Let's say you are willing to risk $1,000.
2. 2. Identify Your Stop Loss
   • Next, determine where you will place your stop loss, which is the price level at which you will exit the trade to prevent further losses. The difference between the current price and the stop loss is your risk per coin or token.
   • For instance, if the current price of a coin is $20, and you set your stop loss at $16, your maximum loss is $4.
3. 3. Calculate Your Position Size
   • To calculate how many coins or tokens to buy, divide your monetary risk by the risk per token. Using the previous example:
   • Monetary risk: $1,000
   • Risk per token: $4
   • Position size = $1,000 / $4 = 250 tokens

This means you can buy 250 tokens, and if the price hits your stop loss, you will only lose your maximum risk of $1,000.