Contributed by Momentum6 labs
Telegram channel – https://t.me/M6bullets
Medium channel – https://medium.com/momentum6
80% of traders lose money. To avoid being part of this percentile, here’s what you need to do:
TL;DR
- Read this article (all of it).
- Learn to speak finance.
- Healthy risk exposure is good; ruinous risks are bad.
- Determine your personal risk profile and stick to using bet sizes appropriate for your current bankroll.
- Establish clear rules for determining when one of your investment theses has officially failed.
- Use regret-minimization strategies to make the mental game easier.
- Plan your trades before executing them to make your decisions easier. Know where your profit targets and stop losses are.
Intro
People new to investing may be surprised to learn that many people lost money throughout the last epic bull run. Fantastic stories like this one make us want to go all-in and think, we all gonna make it, but it’s possible to lose lots of money even when the long-term trend is up only. Many people ‘FOMO’ in at the local tops and get shook out at the local bottom that inevitably follows. The trick to avoiding the temptation to bail when things get scary is actually several tricks, and they’re generally executed simultaneously. We know a few tricks, but we went to find the rest. We’ll start by first defining all the different types of risk we must manage, then break down the strategies that successful risk managers are using, so we can steal their ideas.
First, let’s get the clichés out of the way:
“Winning never feels as good as losing feels bad.” The amount of ‘good feeling’ you get from winning will never make up for the enormous ‘bad feeling’ you get when you lose. Humans have this weird glitch whenever we ‘win’ something; we feel like we deserved to win the whole time, so we’re just not that surprised.
“No one ever went broke taking profits.” Any risk you take off the table will still be there if you mess everything else up.
“When the market gives you a gift, just say thank you.” Recognize when you get lucky, take the gift, resist the temptation to be greedy, and hold on too long.
“Quit while you’re ahead.”– I haven’t heard anyone say this for at least two years. This only applies if you don’t have an edge in whatever game you’re playing.
“You should be buying when there’s blood in the streets, even if some of that blood is your own.” Some old guy like Rockefeller or JP Morgan said this to express the strategy of counter-trading your own emotions to capitalize when most market participants are fearful.
“Buy Good, Sell Gooder.” — American Crypto Wiz, AKA @0xLukeOi poking fun at the occasional retail trader that luckboxes their way to a 100x return by “diamond-handing” a meme coin.
Types of risk
Value can disappear in many ways. Here’s what we’re up against:
- Asset Depreciation — This is gauging the chances of whatever you bought becoming less valuable than the price you paid for it. Like if you bought Dogecoin during Elon Musk’s SNL performance.
- Currency Devaluation, Inflation — Examples: When your government decides to print around 40% of the total global supply of your native fiat currency in less than two years and give it away to everybody, or when your favorite degen farm prints infinite tokens to give away as rewards to liquidity providers.
- Regulatory Risk — It’s not just Rug-pulls and worthless meme-coins we need to look out for. Crypto is still a relatively new financial technology, and as such, it is currently facing tremendous regulatory scrutiny. Whenever there is a non-zero chance that government regulation could dramatically suppress the progress of your favorite asset classes, you once again must attempt to determine that likelihood as a percentage and use this to decide if keeping your entire net worth in Tether’s stablecoin is something you’re comfortable with. Although non-custodial crypto wallets offer an excellent quality of self-sovereign wealth management, and no one can stop us from sending and receiving transactions peer-to-peer, what can be stopped is the ability to convert your crypto back to fiat. If you never plan to sell back into fiat at anything you’ll ever need to buy will be purchasable with crypto, then this particular risk may not be significant.
- Black Swans — Once in a while, you’ll be caught holding too many shitcoins when sudden news about the latest global pandemic or potential nuclear war breaks. It happens. It takes courage to buy these bottoms and not panic sell everything underwater. So far, it’s worked out. So far.
Opportunity Cost — What you could have gained on average by not tying up your capital (or time) in something less performant.
Counterparty Risk — The risk you assume by allowing anyone but yourself to have custody of your assets. These are the most common culprits:
1. Rugpulls — The developers suddenly realize that instant retirement is an option and make a run for it.
2. Hacks — Some anonymous smart guy notices a vulnerability that the developers missed and drains the contract.
3. Getting Blocked or Deplatformed — A centralized platform decides they don’t like you, your political point of view, or your geographic location, and they shut you down.
4. Protocol Risk — The actual code breaks, accidentally burning everyone’s tokens.
These protocols and centralized exchanges offer enticing yield opportunities, but they require us to deposit our assets onto their platform. Be conscious of each platform’s “likelihood to rug” when deciding how much of your net worth you’ll allow being in their custody. Gauge your risk according to things like TVL, daily active users, the age of the protocol, the team, their audit ratings, and everything you can find to help you determine their likelihood, as a percentage, to be around tomorrow. Then, take full advantage of their yields with a sensible slice of your net worth.
What does he have that I don’t have?
Here are the things that successful risk managers are doing that most of us aren’t:
Focus On Mindset
One thing that can do a lot to help you manage risk is controlling your emotions and keeping a healthy perspective about past events. Bad trades and missed opportunities can take a severe mental toll if you beat yourself up over it. The author of The Psychology Of Money, Morgan Houselcovers this extensively. Here’s a thread that does a great job summarizing Morgan’s lessons, and here’s a good take from an accomplished yield farmer and ex-online-poker player on maintaining your sanity in crypto by minimizing regret and managing your emotions well. Poker taught me a lot of good strategies that are easily applied to managing trades and investments. I wrote a bit about it here:
Get An Education
Another common edge among successful risk managers is their knowledge base. In addition to studying human psychology and emotional control, most good ones also have a solid understanding of finance, strong math skills, and sound fundamental and technical analysis tools and strategies.
We covered some basic financial literacy concepts here:
CryptoCred also has an older video covering risk management and trade management strategies and a recently updated one here.
Consider Risk Exposure Carefully
Choosing how much of your net worth to allocate toward high, medium, and low-risk investments can be simplified by taking a minute to reflect on your long term goals, your average remaining time on this planet, and how much of your multi-generational fortune you’re hoping to spend before your expiration date.
A good way to think about risk exposure is “what’s the maximum possible (dollar-denominated) value I can lose if everything crashes as far as I imagine it can.” This will be a different percentage for each high, medium, or low-risk investment class. Mastering this art is just applying math. If you think something can dump 90% from here, maybe don’t put more than 10% of your high-risk roll or 1% of your total net worth. A healthy amount of risk exposure is very good. Exposure to any amount of ruinous risk is bad.
We covered some similar DeFi-specific risk-assessment strategies recently; check out this thread for more excellent tips on assessing risk:
“Risk management includes knowing how and when to take out initials and cut losses. Have rules, even if they’re as basic as “when I start to get excited, it’s time to pull out initials.” Greed is the portfolio killer.” -Stephen The Calculator Guy @phtevenstrong
Accurately assessing your risk vs. reward
This is another handy skill that professional risk managers can do in their sleep. Something with a 90% possible downside can still deserve a bit of capital; it just needs to have a 9000% potential upside. Being able to determine this ratio of risk vs. reward and allocate appropriately is mandatory in the capital allocation business.
Staying disciplined
Good old-fashioned self-control can’t be overstated. A professional’s approach to capital allocation extends beyond defining the percentage of their assets they’re willing to risk to include good planning and execution. An example is planning trades in advance and using limit orders with predetermined profit targets and stop-losses. Stick to the math; no need to let your emotions get involved.
Making It To The End
Risk management is the most important but least popular investing topic, so congratulations on making it this far. Those that take the time to cover and understand these basics will have a huge advantage over the other 80% of market participants. The most common advice I found across all these resources is that survival is the most critical part. Most of trading and investing is patience, waiting for a good setup to enter, and waiting for your thesis to be proven or invalidated. By using this collection of skills and strategies, our bankrolls will always be healthy enough to jump in when good opportunities finally come.
Contributed by Momentum6 labs
Telegram channel – https://t.me/M6bullets
Medium channel – https://medium.com/momentum6
