Risk Management for noobs
Updated: 6 days ago
Risk management is one of the most important skills to learn as a crypto trader. With big profits, come the potential for big losses. Don't wojak your way back to being a wagecuck!
The first skill in crypto people (hopefully) learn is how to make a lot of money in the first place. This takes time, patience and nerve, and not many people make it past this point. Once the money is made, the second skill that should be learned is how to keep it! And many people do not adjust their strategy that made them 20x or 100x and the end result is that they lose everything.
Your stack size should dictate your strategy. Someone on a relatively small initial investment of $1000 should have a different strategy to someone with a mid sized initial investment of say, $20k. If you are sitting on stacks of $100k to $300k and up, your strategy should change to be more defensive.
The smaller the stack size, (and by extension the smaller proportion of your net worth in crypto) the less I would worry about being "all in" or not diversified at all. I initially built my stack by being all in on BTC. If you have a decent trade thesis on a particular coin, apeing all in is not necessarily such a bad move.
People say "you should never have more than 5% of your net worth in crypto" but I don't really believe this. I think it applies to wealthier people. I think if you do the study, put the work in and be prepared to lose your initial investment, putting more than that into crypto makes sense. Nothing else can offer you early financial freedom quite like crypto.
At the time of writing, small stacks would be hard to go past $SOL as the coin that would present the highest probability for the biggest gains. Ape it! Have fun. Everyone in crypto needs to experience the feeling of riding a 10x.
Small stacks should probably prioritise HODLing rather than trading. If you are new to crypto it is probably better to watch the market before you start trying to trade.
I have tried HODLing with larger stacks however the insane volatility means that in most cases it is too risky. I prefer the "scaling" approach for larger stacks. Set say 15% -30% of your stack for scaling purposes. Scale out during rallies, scale in during dumps. Use a pre-set instalment strategy at set percentage levels. If you are going to take a lot of profit, sell in set instalments at set prices.
On the topic of buying down continuing big red candles or "buying the fear" I usually split up my position size into three or more separate instalments and I buy gradually over the course of days or weeks as the dump continues. This way your position can be averaged in, reducing risk.
What happens when you get your first 5x or 10x? I say you should automatically take profit to cash forming 10% of your stack at 5x and another 10% at 10x. Same goes at 20x, etc. Set a rule, and take the emotion out of it. On an insane crypto run you will hardly notice that you took profit when you look at your final balance at the end of the run.
I like to cash this profit to stablecoins and deposit them in high yielding farms / pools. This is a personal preference. I use these high yielding farms to earn interest and dollar cost average back into the coins that I am bullish on. The usual warnings about smart contract risk apply. However, there are now insurance products for smart contract risk! See https://app.insurace.io/Dashboard#myCovers
Over time, you will rebuy your favourite coin, and if it appreciates further in price, you will be earning a lot more than the say, 20% interest advertised on the stablecoin farms. Presently my favourite stablefarm is Saber on Solana. Presently, their rates are far in excess of 20%.
Once you have built your initial stack, you should probably diversify. Diversification used to be a meme in crypto right up until the 2020 bull run. Things are changing very quickly and my personal opinion is that BTC's position at the top of the pile can no longer be taken for granted. I have coins in the BTC, SOL, HEX, BSC and POLY ecosystems.
In my opinion, bigger stacks should keep 15% to 30% in cash at all times. These stablecoins can be used to rebuy BTC or other coins low in times of market panic and it is possible to ride 20% say, then cash back out again at a profit, back into the farms or stablecoins.
In times of market uncertainty, having more cash as a proportion of your stack is totally fine, indeed wise! But isn't the point of trading to acquire more BTC? Holding cash allows us to hedge on the downside of BTC. On the flipside if BTC goes on an insane FOMO run, this cash can be used to buy alts such as DOGE. The catchup rally on alts will usually outpace BTC on the % gain and then these coins can be flipped back to BTC up the run, in profit. In this way we can "hedge" on both sides of the trade, hopefully profiting in BTC on both sides of the move.
On the downside, stablecoins can be used to stink bid on exchanges. I usually try and buy down red candles and wicks. Limit orders are more reliable than market orders and I use $500 or $1k increments (BTC). No one really knows how far the red candles go, and it can be too little or too much. The excess stablecoins that do not hit can be put into alts to ride the catchup rally, to be flipped for profit in BTC.
With farms and pools, smart contracts are inherently less secure than coins held on blockchains like BTC. Therefore, I would not put more than 10% to 15% of my stack in pools or farms. Within these stacks I would split up the stacks into 10 separate stacks split across 3 or 4 different blockchains and different farms also, so there is no single point of failure. Having some pools or farms going is a great way to increase your stack by dollar-cost averaging your favourite coins over time!
Update! It is possible for a single whole blockchain to fail! See Solana, 15 September 2021.
Stablecoin risks are another topic. USDT is apparently only backed by about 50% cash. The other 50% is "undisclosed commercial paper". Commercial paper (debt) is not created equal and this is concerning. Thus, USDT is not for bagholding. USDC is slightly better and has a more trustworthy brand butstill holds a proportion of its reserves as commercial paper. So far as I know BUSD and USDK are backed by cash 100%. I would divide my stablecoin stack up across all the different stablecoins in approximately equal amounts.
Consider the gold backed tokens as another method of hedging risk, for example the Paxos token PAXG. It is backed 100% and fully compliant.
When should you take a lot of profit? It is entirely up to you and a personal decision for you only. The decision for someone with a career is different for someone who is living from their bags. Your own personal risk tolerance and financial circumstances dictate this. Set your own risk management strategy.