#STEEMGIGS: (tutorials) — Trading dangers and risk reduction techniques for the crypto world.

Hello this tutorial is going to be about the dangers of trading, and why we shouldn’t trade cryptos yet, but instead invest them in various ways, I will also mention ways to diminish those trading risks to help those who are certain they want to make profit of trading cryptos.

Trading basics and keywords

First let’s take a look at three long term trading charts: Bitcoin, Etherium and Steem.

I hope that the danger is apparent just by looking, the people who bought at the top lost a ton of money, and those that tried to sell near the bottom will probably have lost significant amounts by now, let’s look at an Forex chart for comparison:

You probably don’t see much difference, but there are real differences that make cryptos much harder to trade.

First let’s take a look at how a trade happens: You pick an exchange or a broker that acts as an exchange, then you pay a fee to buy or sell coins in some cases or you buy or sell a CFD for the value of those coins. Simple, right? However let’s look at a fact: many brokers who started offering cryptoexchange services are winning big time, which means crypto traders are losing on average. Trading is hard, but in the crypto market, sometimes the fee you need to pay to buy or sell coins is high, you cannot buy or sell big amounts of coins either and the price fluctuation is too high, as some old traders say: It's the wild west out there. In order to explain better why, let’s take a look at some keywords we’re going to need here:

·        Volatility: Average % of change between candles.In this example is somewhere around 0.00005, with peaks of 0.0002

·        Intraday volatility: This is also often important, and while you can use any candle for measuring inside volatility, daily candles are most often the ones used, this refers to the amount a candle changes in the very day, for example, suppose that price moves up or down 5 cents in a day usually, and you have a trailing stop loss that follows cent per cent, so assuming you buy at 1.3 once price reaches 1.33 if it goes down to 1.32 you close at 1.32, always one cent lower from the top. Ideally this would help you close near the top, but if the intraday volatility is higher than 1 cent, you’re risking that you get stopped before the top, cutting your profits, or even generating a loss. In this example, the intraday volatility is 0.0006 (more or less)

·        Liquidity: The most important of the three, and directly related to both, liquidity is a measure of the amount of buyers and sellers in a market and very liquid markets are easy to trade, in forex you can purchase millions of dollars or euros and you won’t need to pay huge commissions nor you will get filled far from the price you see in the chart, this is because trillions are traded each day. Try buying 10000 BTC and see what happens… price will fluctuate and you will see a huge green bar and you will buy bitcoins near the 8000$ price (or higher) instead of 6500$, this is because there aren’t many sellers, so in order to fill your order you need to keep purchasing from the more expensive sellers, this is mostly due to the crypto market being a young market and not having enough capital yet, this issue will eventually be solved. In this example liquidity is about 2000 (In comparison, liquidity on Forex is at millions or even billions at times).

Mathematical risk and basic trading formula

Sorry for the lot of theory, but it’s important, because in order to be profitable trading you need to have a trading strategy that at least follows this formula:

Situational Risk * Monetary Risk < (Potential profit * Probability of profit – others)

·        Situational Risk is the mathematical risk calculated by liquidity, volatility, technical analysis, fundamental analysis and others and is directly inverse to probability of profit.

·        Monetary Risk is just the amount of money you want to risk in the trade.

·        Potential profit is the amount of profit you expect to make minimum in a trade

·        Probability of profit is the probability of your trading target getting hit and is inversely proportional to Situational Risk.

·        Others refer to commissions, interests, spread, and others costs incurred from operating the trade.

This basically means that in order to make money on the long term you need to have a higher Risk to Reward ratio (often known as R&R ratio), and the ratio needs to be bigger the greater the others number is. Many traders only use monetary risk and potential profit in the formula, and ignore the fact that betting 5 cents in expectations to win 15 cents but with higher probabilities of losing that winning is actually unprofitable, so the next time someone says he has a 3:1 R&R ratio, ask if they include the mathematical probability of risk in the formula, or are just contemplating monetary risk.

Cryptos are dangerous for traders for now; lack of liquidity and too high volatility increase Situational risk to very high levels as well as increasing the “others” number, requiring a bigger R&R ratio; instead of trading cryptos is better to invest in cryptos, I’ll be covering the topic of investment and how investing in cryptos can be highly profitable in next posts, so look forward to it.

Tips and risk reduction techniques

Okay, so even after explaining the dangers of trading cryptos you want to trade cryptos and become a millionaire and retire early?, let me help a bit by giving some tips that will help you survive.

1-     Don’t place too tight SLs, for those of you that are unfamiliar with what SL means, SL stands for Stop Loss, and is an order of type Stop that helps traders protect themselves and is the ultimate safety net for when everything goes wrong. Suppose that you open a trade to buy steem dollars on an exchange and you place your SL at 2 cents, if price drops two cents then you order is closed and you lose only a small amount… this sounds good, but due to volatility and intraday volatility there are HUGE chances that a tight SL will get hit, for example, supposing I were to buy Steem Dollars at 1.28 (and with increasing momentum), I would buy it until it’s worth 1.5 and place my SL at somewhere near the 1.1 level, I have a safety net in case everything goes to hell, and normal volatility or lack of liquidity won’t hit my SL, so it will depend mostly on technical analysis and fundamental analysis, this reduces situational risks enormously.

2-     Be patient and have confidence in your analysis, or just be patient, in my introductory post I showed a chart about Toyota back in the 1978, it was worth about 5 dollars, then fell to 3.8 dollars per share, today it’s worth about 50 times more, those that bought at 5 dollars and got out when it was worth 4 dollars lost quite a lot of money, but those that held on became millionaires and proud owners of a huge company.

3-     Diversify. Diversification is the father of risk reduction, instead of gambling your house on one coin, it’s less risky if you buy 10 or 20 different coins and sell 10 or 20 different coins as well (depending on commission of course), and it’s even less risky if you also invest in stocks, commodities, real state and so on. Diversification helps reduce situational risk and will provide you with a more stable return (whether profitable or not will depend on your strategy and not on random factors). You can find mathematical explanations on the value of diversification everywhere, like here, but if you'd like a simple and colloquial explanation, just ask me.

4-     Use small amounts. Combined with diversification this is a lifesaver… Instead of going all in or to use leverage to use even more cash than you normally have; manage your risk so that in one position with a wide stop loss you lose only 2 or 3%, this means if you have 7000$ dollars you cannot buy a bitcoin since it’s too risky and you should instead buy about 0.2 bitcoin, so that if price moves 10%, you lose only 180 dollars, instead of 700 or more, true, you'll lose the chance to win 700 as well, but if you diversify as well you should end up winning more in the long term.

5-     Don’t get greedy. Positions with small targets are more likely to get hit and generate profit than positions with bigger targets, remember the formula:

Situational Risk * Monetary Risk < (Potential profit * Probability of profit – others)

If your probability of profit is high enough then even if your potential profit is small you can make cash in the longer term. People calling bitcoin to 50 K aren’t being realistic, those that plan to sell BTC at 6800 or 7000 have better chances of actually getting cash.

6-     Final tip, DON’T GET IN LATE. I’m putting it in uppercase because it’s a major reason for losing cash, for those that use technical analysis and are good at it (don’t worry if you aren’t as I will explain more in upcoming posts) sometimes we see a good entry, we enter… time passes we get stopped (hopefully with a profit) and see that prices keep moving in the direction so we’re tempted to get in again LATE, and price reverses and takes our earnings and maybe even more, get in only when you get the signal, if you’re late to the party, bite your lips and wait for another chance.

This is a very long tutorial, and I haven’t even touched the tip of the iceberg, feel free to google or ask for more information, ICOs are very similar to penny stocks right now, so use your google-fu to search how to trade penny stocks and you’ll see what I mean. On another note, if you want to practice trading before using real cash I suggest you take a look at tradingview.com, it’s free and you can learn many things there, though I strongly advise you avoid the cryptocurrencies chat or you can easily get lost and forget what your objective was in the first place…

Final words

Fun fact: While I’m profitable trading Forex, I’ve never managed to make a winning trade on cryptos on the demo offered by trading view (I’ve tried about 30 trades by now), and the demo doesn’t even include spread, commissions, and others, don’t underestimate the difficulty of trading this market.

As I always say, feel free to upvote, downvote or don’t vote at all, just leave a comment if you liked the post, give your suggestions, opinions and perhaps mention other things you would like me to analyze and explain.

Kind regards and happy trading.

Eilder Jorge