Crypto Futures Risk and Money Management | by LBank Exchange | May, 2023

From the LBank blog.

Crypto Futures Risk and Money Management

Crypto futures trading is a popular choice for many traders due to its potential for high earnings and leverage. However, the volatile nature of cryptocurrencies means that even a small mistake could result in substantial losses. It’s crucial to implement proper risk management strategies to minimize potential losses.

To establish a strong risk management approach, traders should focus on position sizing, setting and adjusting stop losses, and assessing the risk/return ratio. These are critical components that can help mitigate risk and protect investments.

Despite the allure of high profits, it’s important to recognize the significant risks associated with crypto futures trading. By implementing effective risk management strategies, traders can navigate the market with greater confidence and safeguard their capital.

Money management goes beyond simply managing your finances. In the context of trading and investing, it encompasses a wide range of factors that can have a significant impact on your overall success. However, due to the limited scope of the term, there is often confusion about what it really means.

Effective money management includes a variety of elements, such as determining the maximum percentage of an account that should be put at risk, managing the number of shares, contracts or lots traded at any given time, and deciding when to add or close positions based on realized profits or losses. Additionally, it involves placing stop orders and other measures to control risk, identifying opportunities for profit-taking, and implementing strategies for minimizing losses.

Other key components of money management include hedging, diversifying your portfolio, and developing strategies for determining the profit-to-risk ratio of specific trades. While this list is not exhaustive, each of these elements is essential to effectively managing your finances.

To fully understand and apply effective money management, it is important to delve into each of these components in greater detail.

Your total risk refers to the maximum percentage of your investment that you are willing to put at stake. Experts usually recommend a range of 2% to 5%, with some suggesting even lower, at ½%. It is crucial to consider the potential losses that may occur if a trade or investment does not turn out as expected. Conversely, the less you put at risk, the lower the potential gains you may receive. It is essential to note that the percentage of risk varies depending on the type of trade or investment, as some carry more significant risks than others.

It is important to clarify that the percentage of risk discussed here only pertains to the amount that you are putting at stake at a particular moment. It excludes transaction costs or margin requirements for futures trades. The amount of risk you are taking at any given time depends on several factors, such as where you set your stop-loss orders and other loss prevention strategies.

For instance, if you have an account worth $100,000.00 and you put $2,000.00 at risk in a trade, your risk percentage is 2%. Suppose you have already reached your maximum risk limit of 2%, and you lose the $2,000.00. In that case, you will be unable to make another trade without adjusting your total risk percentage. You will need to take into account the loss and recalculate your new total account value, which is now $98,000.00, allowing for a new risk of $1,960.00, which is still within the recommended range.

This is a well-known strategy among investors. It involves spreading your trades across a wide range of markets to protect them from being negatively impacted all at once by the same factors. While it may not fully shield your investments from major crypto market declines, as we have recently experienced, diversification can protect you from typical market panics that are specific to certain markets.

What is the appropriate number of contracts for a trader to trade?

Consider the case of Trader A, who has set up a futures trading account with an initial margin balance of $3,500. Although he is excited about trading five contracts, he is overextended because he is risking 22% of his account balance, which is a high level of risk. Proper money management requires that a day trader risk only 5–7% of their total account balance on a given trade, and an aggressive trader might be justified in risking up to 10%. Therefore, an experienced trader should trade two contracts, risking $300 or less than 10% of their account balance. In contrast, a novice trader should trade only one contract, while anything more than two contracts exposes the trader to unacceptable levels of risk.

Money management is all about managing risk. A wise trader avoids excessive risk and potential financial ruin. Crypto Futures trading is not a get-rich-quick scheme, and one secret to success is managing your money properly. Therefore, learning to trade the number of contracts that align with your futures account balance is a crucial skill to master. Ensure not to overtrade your account and implement proper money management techniques.

Disclaimer: The opinions expressed in this blog are solely those of the writer and not of this platform.

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