The basics of risk management and money management in cryptocurrency trading

WHAT IS MONEY MANAGEMENT AND RISK MANAGEMENT?

MONEY MANAGEMENT

Money Management – these are strategies for managing money. It includes a set of principles and cash management systems intended for investments. In other words, these are rules for capital preservation.

There is a popular opinion that money management is a trading strategy. However, this is not entirely true, as the goal of money management is to minimize capital losses.

Why is it necessary to adhere to money management?

Trading and investing are heavily influenced by psychology. It is often seen that people, seeing the opportunity to get "life-changing money," lose complete control over themselves.

You and only you control rational behavior during periods of market uncertainty.

Fight losses, not increase them.

This may seem simple, but without setting your financial management rules from the very beginning, every investor will face this problem.

If there is a money management plan, even if something goes wrong or the market becomes unfavorable, you will still be safe. Yes, on the one hand, this will not increase your capital, but on the other hand, such actions will limit potential losses.

Basics of money management:

• Do not invest all the money in one transaction.

RECOMMENDATION: It is better to open several positions or leave part of the capital for averaging.

• Patience is the investor's best friend.

RECOMMENDATION: To achieve maximum profit, time must pass.

• You have earned if you have converted the profit into cash.

Money Management Rules

All money management rules can be divided into two groups:

Asset Management

Determines:

• what part of the capital to spend on this or that asset;
• when money can be spent;
• what part of the money to leave for future investments.

Determination of trading volume

Allows:

• maintaining a balance between the position size and the volume of capital. This will avoid losses in case of failures.

!!! NOTE: losses in trading or investments are a normal process. Even if money is managed effectively, you may encounter losing trades.

RECOMMENDATION: for probability theory to be on your side, the deposit should be enough for 15-20 trades, not 3-4.

Thus, an investor should have a cool mind and strong nerves.

By following the principles of money management, you can form a discipline that will protect you from unreasonable purchases, which will increase confidence in your actions.

The term money management is closely related to risk management. It is important to understand that they do not replace each other but complement each other.

RISK MANAGEMENT

Risk Management – this is the understanding of how much money you can lose in the process of trading or investing.

Main Principles of Risk Management

Three principles on which risk management is built:

Minimization of transaction risk — The difference between the purchase price and the stop-loss.

Minimization of capital risk  — The total threshold, at which the risk of all trades should not exceed 20-25% of the total capital.

For example, if you close all orders with a loss, you should still have 75-80% of your initial investments.

Determination of transaction profitability — The ratio between risk and reward[1] should be 1:3.

In turn, the profit is the difference between the entry point and the profit fixation point.

Thus, risk and money management are the foundation of investing and trading. Applying and understanding their principles will ensure confident growth of your capital over time and protect it from potential losses.

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[1] Risk reward – this is the ratio between the possible loss and potential profit in a trade or investment. Simply put, it is an assessment of how much you can lose and how much you can earn if you take the risk. Using the risk-reward ratio helps make more informed decisions by assessing whether it is worth risking for the potential profit.