The cryptocurrency market is still quite new and unusual for most forex traders. Non-standard, as compared to traditional currency pairs, trading conditions are most confusing, which complicates the calculation of risks when opening a position in crypto. Today we will deal with the intricacies of calculating risks in the cryptocurrency market, and try to put together all the main nuances of the processes that are taking place.
Many traders confuse the concepts of money management and risk management. The former is the ability to manage funds, while the latter is the ability to limit one’s losses during trading.
Trading in financial markets is a high-risk means of earning. Making profit in the trading process is not yet a complete guarantee of the success of all trading activities. It is very important to learn how not to lose income. Risk management is part of the trading system, indicating a specific number of lots used at a particular moment of trading. In other words, this is a bet size control.
The author of the book "Exchange Game" Ryan Jones points out the fact that in most cases, reflecting on the volume of a newly opened position, traders act instinctively, relying on their hunch. Such approach accounts for more than 90% of losers in trading. Professionals, using certain counting systems, determine exactly what amount of money you can risk when opening the next position. They use such systems productively and constantly. “Trading is a game in which there is a reward for risk,” says Jones.
Since all Forex trading is mainly based on the emotions of the trader, risk management serves to exclude the emotional component and to streamline the process. Total profit is the sum of the results of profitable and unprofitable transactions.
Currently, a lot of money management rules and methods for determining the risk per deal have been developed. Money management can be divided into two categories: right and wrong. The first category takes into account risk and the rewards received for it. Thus, the full range of available capabilities is used. The second category takes into account either risk or profit. In this case, only certain characteristics of the account are taken into account: the percentage of successful trading operations or the ratio of profit and loss.
The Importance of Risk Management in Trading
When trading on Forex, risk management is, in fact, the most important aspect. It helps the trader to "stay in the game." Total market success ensures optimal money management. Therefore, you should consider in more detail what it is.
Novice traders quite often do not take into account the randomness of events taking place on Forex and do not fully understand the issues of probability. Some of them willingly believe that brokers artificially create false candles and prematurely close Stop Loss. It is these newcomers who often have their deposits “drained”.
The concept of mathematical expectation is extremely important for traders:
- Positive expectation is the player’s advantage in the ongoing game.
- Negative expectation is an advantage of a gambling house.
An example is the flip of a coin in order to identify the advantages of an “eagle” or “tails”. In this case, their chances are equal: 50 to 50. Therefore, the probability of winning is 50%. However, for such actions in the casino, a player will be charged 10% of the commission for each toss. Thus, the advantage of the gambling house makes the mathematical expectation of the player negative. It should be understood that not a single money management system will stand up against a negative mathematical expectation. Sooner or later, the size of the deposit will become equal to zero. It is the matter of time.
A player will succeed only in case of a positive mathematical expectation. Unfortunately, trading in financial markets, and in particular in Forex, has a negative mathematical expectation. Like a 10% casino tax, swaps, spreads, and fees for transferring funds to accounts have a negative impact on trading. Therefore, the trader should look for a positive mathematical expectation in any way.
When developing or optimizing a trading system, it is necessary to strive to ensure that it is tough and practical. A smaller number of its components will minimize the possibility of losses. The settings should be floating and depending on certain market parameters, for example, volatility.
Before applying the trading system in trading with real funds, you should test it using a long historical period (preferably at least 5 years). And only after making sure that it works correctly during testing, you can use the developed set of rules in real trading. It should be noted that all results are evaluated in a complex.
Having a ready-made trading system, you can already set the rules for money management. High positive mathematical expectation for this system will be given by the correctly selected position size and trading according to strictly developed rules.
The amount of capital that you can risk
Emotions and ignorance, as a rule, can play a cruel joke with novice traders. They often open orders intuitively and enter the market when this should not be done. Subsequently, gaining experience in trading, these traders are already beginning to adhere to a specific trading system. However, the first successes in the market make them greedy, and newcomers unreasonably risk too much in one transaction. A few unsuccessful transactions made under the influence of emotions can easily drive a deposit to zero.
By risking a quarter of the capital in the account, you can quickly approach a financial collapse. Even the best trading system cannot prevent it. If you risk a tenth of the funds, trading activities will last for some time, but the final will also be disastrous.
Numerous market studies have shown that no more than 2% of the deposit should be used in trading. Some experienced traders even consider this limit to be too high and reduce it to 1%. This is no coincidence, since when attracting additional investors, it is very prudent to show a lower percentage of losses.
When managing money, you should adhere to strict rules:
- ensure your survival in the market and avoid unjustified risk in every possible way to. Strictly limit possible losses in advance;
- achieve a steady profit from transactions;
- get super profits.
The last two rules are feasible only with strict observance of the first. It should be remembered that you need to get rich slowly. In trading in the financial markets, one should never rush into the pursuit of big profits. In no case should you risk all the funds available on the account.
Disputes about earnings do not subside in many thematic forums. It is believed that if a trader makes 40% of income per year and secured this success for 5 years, he achieved a lot. A trader who can double his capital in one year is considered a rarity. Therefore, it will be right to set modest goals and achieve them. In fact, this is the only true way to get good statistics with regular profit and low losses. Experience shows that real incomes are incompatible with high risks.
Total net profit
The total net profit as a result of trading will be equal to the difference between gross profit and gross loss. This feature most fully gives the investor information about the possibility of a trading system.
Net profit per se has virtually no meaning. It must be considered, broken down by different periods of time, even by year. However, to make a final decision, other parameters should be considered.
This is one of the components of risk management in the market. Anyone can have both successful and losing trades. An experienced trader minimizes drawdown, unlike a trading beginner .
The maximum drawdown is considered to be the degree of the greatest loss that may be on the trader's account. This is the maximum decrease in funds, fixed from the local maximum (the difference between the extremes of cash on deposit). Moreover, this value is measured in the deposit currency.
For example, the account had 400 dollars. Closing the first order brought a profit of $ 50. The second deal was unsuccessful, indicating a loss of 100 USD. Then again a loss of 50 USD. And again the profit is 20 USD. As a result of several profitable and unprofitable transactions, the amount of funds decreased to $ 320. The difference between the local maximum of 450 USD and the local minimum of 300 USD was 150. This is the maximum drawdown.
This indicator determines the size of the real trading risks. Its value may even be greater than the initial size of the deposit, when first a profit is made, and subsequently - large losses.
When testing a trading strategy, an important characteristic is the Recovery Factor. This is the ratio of net profit received as a result of trading activities to the maximum drawdown. As a result, the profit size per one dollar loss is visible. A trading method where the Recovery Factor value is less than one cannot be effective. In general, experienced traders consider the system advanced when the value of the recovery factor is at least 3.
Even a very superficial analysis of the parameters of any trading system can show how effective it is. For example, if a certain trading method promises 80% of profit per year, this is a pretty good harbinger of prosperity. But when at the same time the maximum drawdown is 60%, it is quite possible to reduce the deposit by more than two times, and possibly drain it.
Increasing the maximum drawdown as a result of several unsuccessful trading operations can adversely affect the psychological state of a novice trader. He has an acute desire to quickly restore the loss of funds. However, one should not succumb to emotions. Be sure to follow the rules of the already selected trading system and do not forget: drawdowns are an integral part of any trading.
Average win / lose ratio
This indicator, combined with the percentage of profitability, gives the investor or trader a lot of useful information for making cardinal decisions. System trading can be seen as a game of numbers.
The combination of the gain / loss ratio and the percentage of profitability provides significant assistance in calculating the reserve for error and allows you to understand the logic of the method used in trading. For clarity, this dependence can be considered on the graph.
It can be seen that with a ratio of the gain / loss and the percentage of profitability of 1/50 break-even trading occurs. It is easy to see that lowering the value of the second parameter entails an increase in the first. Conversely, a decrease in the percentage of profitability increases the gain / loss ratio. Its value should be equal to at least 4 in order to provide 20% of the profit.
Usually in good trading systems, the ratio of these parameters is 5 to 10.
The ratio between the maximum and average winnings
In this parameter, the ratio of the maximum and average loss is taken into account. This indicator will be useful for determining the potential for maximum profit. However, every investor should remember that such luck should not be fully relied upon, but still it will be pleasant.
When the maximum winnings are several times (three or four) more than the average, then you should not particularly expect to receive it. In the case when its value does not exceed the sum of three average winnings, there is a high probability that further use of this trading method will give an even greater profit compared to the initial one.
Probability of financial collapse
The Probability of Ruin (POR) indicator reflects the likelihood that the balance in the trader's account will decline to a certain point earlier than rise to another, higher point. Thus, the chosen trading method can ruin a trading account. The loss will be visible at the very level of the account at the time of termination of trade. POR clearly reflects the movement of the selected system to success or ruin.
It will always be useful for any trader to know this value. To calculate the probability of ruin, you need to determine all the parameters of a very complex equation. It is important to consider the following patterns:
- Probability of Ruin decreases with increasing size of average wins.
- POR increases if the average risk of the transaction increases.
- The size of the initial deposit also affects the probability of ruin. The larger it is, the less POR.
- Increasing the percentage of winning trades reduces POR.
- Too small a deposit increases the likelihood of its ruin.
As a rule, the value of Probability of Ruin does not exceed 5%. But it is important that this indicator informs traders in a timely manner about a possible rapid financial collapse. In this case, you should reduce the risk of each subsequent transaction and try to reduce the POR to the desired level. At the risk of a very insignificant part of the funds on deposit, the trader definitely increases the chances of success. If there is a choice between two trading systems, you should choose the one where the risk of ruin is lower.
This parameter, important for a trader, is called Profit Factor. It is also an integral part of testing a trading strategy and allows you to evaluate its effectiveness. It is most popular with traders.
The calculation of the indicator is simple. Unprofitable and profitable trading operations are summarized. A value of at least 1.6 is considered optimal for Profit Factor.
If the profit factor is greater than 1.6, this indicates an increase in the efficiency of the chosen trading method. Profit Factor is the result of dividing gross profit by gross loss for a specific period of time. It is advisable to calculate it over a larger time period, since then it is more objective.
- S (Pi) / S (Li) = Profit Factor, where
- S (Pi) is gross profit, and S (Li) is gross loss.
Obviously, in the event of increased losses, the trader cannot count on profit. Profit Factor plays the role of a kind of filter that identifies low-effective trading methods that can quickly reset a deposit. The indicator reflects not only the result, but also the dynamics of the trader. It brings real benefits in a number of cases:
- evaluation of your own trading;
- study of the investment proposal;
- analysis of the offer of sellers.
Experts advise choosing several key indicators that provide information about risks, profits and some relationships between them. In order to evaluate the work on the market and improve the way of trading, it is necessary to analyze the entire trading process, and not just the end result.
Trading conditions in cryptocurrency trading
Most cryptocurrencies are paired with the US dollar. That is, the unit of cryptocurrency is expressed in dollars, which means that the cost of a point is easy to calculate by multiplying the size of the point, the size of the contract and lot. In MetaTrader 4, the contract size can be found by opening the tool specifications window. To do this, in the market overview, right-click on the desired symbol and select “Specification”.
Here you need to pay attention to two lines:
- “Accuracy”, which displays the number of decimal places in the instrument quote;
- “Contract Size”, which displays the number of currency units in a standard trading lot.
Suppose we want to open a position in 0.1 lots. It turns out that the cost of one XRPUSD item is: 0.00001 * 1000 * 0.1 = $ 0.001, or 1 cent for the old items.
But monitoring myfxbook for a whole point of Bitcoin considers a change in the rate by 1 dollar. For ETHUSD and LTCUSD - 1 cent. Given the variability of the course, the concept of a minimum point may change, therefore, when analyzing monitoring, pay attention to the method of calculating points.
Particular attention should be paid to leverage. Due to the excessive volatility of cryptocurrencies, brokers are in no hurry to increase credit security, as a result of which leverage of more than 1 in 10 is very rare, and most often they are limited to 1 in 3.
You can find out leverage under a specific contract, again, through the specifications window. A “margin percentage” of 10% means that you are only 10% of the total contract amount to secure a position - we have a leverage of 1 to 10.
If you are used to trading on Forex, where the leverage, as a rule, is a couple of orders of magnitude greater, obviously calculating the amount of collateral will be a good habit. Otherwise, you simply may not have any free funds left in your account and will knock out the position by stop out.
Calculating the amount of collateral is also quite simple. To do this, we need to know the size of the contract, the percentage of margin (leverage), the current price of the instrument and the size of the lot. For example, we calculate the size of the collateral for the pair XRPUSD: 1000 units. XRP * 10% * 0.20125 * 1 lot = $ 20.
In order not to calculate everything manually, you can use the auxiliary indicator UrovenZero. The indicator displays the maximum number of lots to buy, the minimum possible deposit, the value of a point and much more on the instrument chart.
The indicator is set in the standard way. To get started, download the indicator file, then in the terminal go to File - Open the data directory, and transfer the indicator file to the Indicators folder. After restarting the terminal, the indicator will be displayed in the navigator panel.
When making transactions, the indicator displays the moment of opening and closing a transaction on the chart, and can also display profit levels, breakeven and average price of a common position.
When trading one pair, the risk per trade should not exceed 1-2% of the deposit. To correctly calculate the position size, use the lot calculator on our website.
Here, select the currency of the account, the size of the initial deposit, the percentage of risk from it, the value of stop loss and the currency pair. Click “Calculate” - the lot size will be displayed in the “Results” column.
Since the cryptocurrency does not depend on the central banks' work schedule and is traded in a decentralized manner, the concept of weekends as such is also absent. Therefore, if it is convenient for you to trade on the weekend, trade only on the weekend, since the market provides such an opportunity. But, it is worth considering that the market on weekdays and on weekends is slightly different, therefore the same strategies can show themselves differently, depending on the day of the week.
In general, due to large fluctuations, it is difficult to find a stable system for trading one currency. It is best to trade a portfolio of several currency pairs, thus diversifying risks. Cryptocurrency rates are weakly correlated with fiat money, so it is a good idea to trade Forex tools at the same time as cryptocurrencies, or even combine them within a single system.
It is very important to keep track of news releases. The cryptocurrency market reacts very sharply even to the most insignificant, it would seem, announcements. The only message on social networks can cause a sharp increase or drop in the rate, and here you need to be fully equipped.
Even if you trade an adviser, or the indicator considers risks for you, in any case, you need to know the nuances of working with cryptocurrencies. Otherwise, panicking and making a mistake in an emergency will be easier than ever. Therefore, we remember about a small leverage and the non-standard size of contracts – lin these moments, newcomers often make a mistake, adopting the characteristics of the main Forex currencies. Also, do not forget about the strong volatility and influence of the news.
Author: Kate Solano, Forex-Ratings.com