Trading Risk Management: The First Step in Securing Your Capital

No matter the size of the capital you're investing, sensible risk management is key to protecting your investment from significant losses. A single poorly managed trade can erode weeks or even months of accumulated gains. The core principle behind this is to avoid making emotional decisions when trading or investing. Risk management in finance, in particular, tests one's ability to control emotions, making it essential to have a set of trading principles, or a trading strategy, to guide investment and trading decisions.


This strategy aims to reduce risk while eliminating unnecessary decision-making interference. It does so by setting a series of decision-making principles, preventing investors from making impulsive and hasty choices during trades. Creating a trading strategy involves considering various factors such as the investment timeframe, risk tolerance, and funds available for investment.


The core of this article is how to determine the appropriate size for an individual trade. To do this, we first need to understand the total size of your trading capital and the level of risk you are willing to take on each trade. Such groundwork is fundamental in formulating a trading strategy, managing risk, and ultimately protecting your capital. In this rapidly changing era, Web3 technology is gradually permeating our lives, with its impact on sports, music, and fashion becoming increasingly evident. However, before exploring these changes, understanding and implementing effective risk management strategies is crucial. This article aims to explain how to apply these strategies in investing and trading, preparing for the opportunities that Web3 brings.

Determining Account Size: The Foundation of Investing

Before entering the investment realm, determining your account size is a seemingly simple yet crucial step. This process is especially critical for beginners as it involves allocating funds according to different investment portfolio strategies. This way, investors can more effectively track the performance of various strategies and reduce overall risk.


For example, suppose you are optimistic about the long-term growth potential of Bitcoin and decide to purchase Bitcoin to store in a hardware wallet as a long-term investment. This portion of funds should be segregated from your investment capital and not included in daily trading or other short-term strategies. In short, determining your account size means clarifying the amount of money you are willing and able to dedicate to a specific trading strategy. This step helps investors clearly understand the range of funds available for investment, laying a solid foundation for creating a sensible investment plan.

Determining Account Risk: Seeking Safe Boundaries

The second step on your investment journey is to precisely identify the level of risk you are willing to take for each transaction. In simple terms, this involves deciding which portion of your account capital you are willing to expose to risk.

The Wisdom of the 2% Rule

In traditional finance, the widely known 2% rule offers a fundamental guideline: the risk for any single transaction should not exceed 2% of the total account balance. This principle is designed to protect investors from significant losses that could result from a single poor trade. It is particularly suitable for conservative investment styles that involve a small number of long-term trades and is generally applied to assets with lower volatility.

Adjustments for the Cryptocurrency Market

However, given the high volatility of the cryptocurrency market, adjusting this rule to a more cautious 1% has become an especially important recommendation for newcomers. This does not mean that only 1% of the total account balance is allocated to each trade; rather, it implies that if the trade goes against you and a stop-loss is triggered, only 1% of your capital will be lost. Such a strategy provides an added layer of protection, ensuring that even in the worst-case scenario, your account won't suffer a fatal blow, thus allowing investors to survive in a volatile market while seeking opportunities for success.

Determining Trade Risk: The Importance of Failure Points

Trade Philosophy and Stop-Loss

Once the account size and risk have been determined, the next crucial step is to specify the exact risk for each trade, i.e., when to consider the trading idea a failure. This step is critical for any strategy, as losing money is inevitable in trading and investing. Trading is essentially a game of probabilities, and even the most skilled traders cannot guarantee profit on every trade. The key is to achieve profitability through proper risk management and strategy execution.

The Core of Risk Management

Effective risk management means setting clear exit points for each trade, where losses are stopped immediately if the market moves against your initial judgment. In practice, this is often achieved by placing stop-loss orders at specific positions. The placement of stop-loss points varies according to individual trading strategies and habits, and may be based on technical analysis indicators such as support or resistance levels, or other factors that affect market structure.

The Importance of Personalized Strategies

There is no one-size-fits-all stop-loss point in the market, so it's important to find a strategy that best suits your trading style and determine the conditions under which your trade would be considered a failure. By doing so, investors can limit losses in adverse market movements and ensure the preservation and appreciation of capital over the long term. In highly volatile markets, flexible and precise stop-loss strategies are crucial to protect investors from significant losses due to sudden market reversals.

Calculating Position Size: The Art of Balancing Risk and Strategy

Basic Theory

In investment strategies, calculating the appropriate position size is key to managing risk and maximizing returns. For example, with a $5,000 account, if the rule is set so that each trade risks no more than 1% of the account, i.e., a maximum loss of $50, this provides a clear framework for risk limitation.

Applying the Formula

After determining a failure point of 5% for a trade, the position size can be calculated using the following formula: Position Size = Account Size × Account Risk / Failure Point. In this example, the position size is calculated to be $1,000, meaning that at a 5% failure point, the exact loss would be $50, matching our set risk limit for the account.

Impact of Strategy Adjustments

When we adjust the failure point to 10%, keeping other parameters constant, the position size accordingly reduces to $500. This adjustment intuitively demonstrates the relationship between the failure point and position size: with a constant willingness to absorb loss, increasing the stop-loss range means reducing the position size.

Considerations in Practice

When applying this model, one must consider trading fees and the potential depreciation risk of low liquidity assets. These factors may affect the final investment return, so they should be carefully evaluated when calculating position size.

Conclusion

In the world of investing and trading, risk management is the key to success. This article has detailed the importance and methods of determining account size, account risk, trade risk, and calculating position size. Through these steps, investors can establish a scientific trading strategy that maximizes protection against unnecessary losses.


With the rise of Web3 technologies, new investment opportunities and challenges emerge, but the basic principles of risk management still apply. Looking ahead, investors should continue to learn and adapt to the changes brought about by emerging technologies, while adhering to robust risk management strategies to navigate the increasingly complex market environment.