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Risk Management Techniques Matter

Risk Management Techniques Matter

Daniel McCarthy, Strategist

“In speculative markets, you win not by picking the soundest investment, but by picking the investment that others, who are playing the same game, will soon bid up higher.” – John Maynard Keynes

A quote from a hundred years ago remains as pertinent as ever when considering the outlook for crypto currencies. In early 2013, I was working in a trading room and watched in amazement that an “asset” had gone from USD 10 to over USD 100 in a matter of months. A room full of professional traders could not believe they had missed an opportunity like this – a ten bagger.

Research and investigation into bitcoin left me none the wiser of the merits of this new currency. I walked away. At the start of 2021 I tried to re-enter bitcoin and duly set about working on entry and exit levels to optimise return and mitigate the downside. The problem was that I applied standard risk management techniques. Bitcoin has wide spreads and high volatility. Traditional risk management meant that I reduced position size. However, wild swings in price saw my stops being clinically taken out on a regular basis.

The problem is that bitcoin can literally go to zero. It may not, but it could. In my opinion, the correct stop loss level for a long position in bitcoin is USD 0. In hindsight, my position size should have been much smaller. Investment managers look at a number of measures to weigh the worthiness of an asset on a risk adjusted basis. Investors will look at the expected return against the risk being undertook. Sharpe or Sortino ratios are lined up against maximum drawdown and many other measures of risk.

There is no perfect measure of risk and as traders, profit or loss drives risk management. Value at Risk (VaR) is a measure used by many financial firms to analyse the probability of a loss. It takes into account the volatility of an asset and the expected maximum loss within the parameters stipulated. If I had looked closer at the bitcoin VaR reading, this would have reduced my position size significantly as well and allowed me to stay in the trade.

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.

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