Risk management techniques are important


“In speculative markets, you win not by choosing the soundest investment, but by choosing the investment that others, playing the same game, will soon outbid.” -John Maynard Keynes

A quote from a hundred years ago remains more relevant than ever when considering the outlook for cryptocurrencies. At the beginning of 2013, I was working in a trading room and I saw with astonishment that an “asset” had gone from 10 USD to more than 100 USD in a few months. A room full of professional traders couldn’t believe they had missed an opportunity like this – a ten bagger.

Researching and investigating bitcoin left me with no opinion on the merits of this new currency. I moved away. In early 2021, I tried to re-enter bitcoin and duly started working on entry and exit levels to optimize returns and mitigate downsides. The problem was that I was applying standard risk management techniques. Bitcoin has wide spreads and high volatility. Traditional risk management meant that I reduced the size of the position. However, the sharp price swings have caused my clinical stops to be removed on a regular basis.

The problem is that bitcoin can literally drop to zero. It may not be, but it could. In my opinion, the correct stop loss level for a long bitcoin position is 0 USD. Looking back, my position size should have been much smaller. Investment managers look at a number of metrics to weigh the value of an asset on a risk-adjusted basis. Investors will consider the expected return against the risk taken. Sharpe or Sortino ratios are aligned with maximum drawdown and many other risk metrics.

There is no perfect measure of risk and as traders profit or loss determines risk management. Value at Risk (VaR) is a measure used by many financial companies to analyze the likelihood of a loss. It takes into account the volatility of an asset and the maximum expected loss within the stipulated parameters. Had I taken a closer look at bitcoin’s VaR reading, it would also have reduced my position size significantly and allowed me to stay in the trade.

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