Volatility is an inherently market risk. It plays into your hands and then lays waste to all your plans, like water, which can both nourish and destroy. Risk management is an art that directs the process of portfolio management in the right direction. The rules of risk management are often neglected when everything is fine, when the market moves according to the forecasts. But should a tendency change, every attempt by a trader to fix something suddenly falls under the category of “too little, too late.”

“… your success in terms of risk management will be determined by your desire and ability to effectively adjust the contents of your portfolio so that it serves the purpose of controlling risks and preserving capital, and from time to time this will go against the actions that you would made, are you not limited by the limits of your ability to incur losses.”

Kenneth L. Grant
“Trading Risk: Enhanced Profitability through Risk Control”

The Discipline of Exchange Trading

Risk management has two aspects. First, it is a discipline in exchange trading, and second, it is the assessment of the value that a portfolio can lose. At the heart of risk management is mathematics, and its main task is to determine how strongly market volatility threatens the value of a portfolio.

Planning (setting goals and trading strategies, analyzing profitable and unprofitable transactions) is an important element of risk management. For example, successful traders conduct a comprehensive analysis of the asset at the beginning of the trading day, which includes:

  • An analysis of the movement of the pair on different timeframes
  • A construction of trend lines, support and resistance levels, and the channel on the chart
  • The identification and fixation of the three nearest support and resistance levels
  • The building of indicators used in the framework of a trading strategy on the chart (indicators provide evidence of the intentions formed from the analysis of the chart)

Risk management and proper portfolio management involve a struggle for each item. In this regard, it is important to choose a specific opening point an expected goal, as well as to outline the closing price of a position at a loss, when analyzing a pair. If the expected profit does not exceed the intended risks, it is not recommended to open a position.

One of the principles of successful trading is making profits grow. However, the absence of specific goals for the desired yield of a transaction often leads to losses. Make use of take-profit orders and the PnL ratio calculator available on the Xena Exchange terminal to calculate your optimal closing position.

The creation of a trading plan should be followed by its implementation. By following logical principles and building a strategy “on paper,” the trader is safeguarded from emotional decisions. Keeping a diary helps novice traders answer the perennial question — “Why did this happen?” — and helps them avoid mistakes.

“Life is more risk management, rather than exclusion of risks”

Walter Wriston

Comparison of Successful Periods

One of the most important methods for diagnosing a portfolio is comparing decisions regarding the composition and structure of the portfolio during periods of sustained success and in periods when nothing is going well. Factors such as the dependence of the trader on the news background, specific market orientations, or simple luck are taken in consideration. Many traders rely on forecasts made by other market participants, which, by and large, can be considered financial negligence and often leads to disastrous consequences.

These statistics constitute a general diagnostic tool that allows traders to highlight aspects that can be improved. However, one should not make hasty decisions and remove factors that may seem like weak links. A change in one factor may unleash an undesirable change across the whole chain.

It is necessary to establish some reference indicators for the proper assessment of the indicators, and one of these indicators is time. When describing performance analysis using a time series, Kenneth L. Grant highlights the need to identify an adequate time interval within which the used indicators are evaluated, as well as the need to define the unit of time that would give an idea of ​​the particular value of the indicator.

  1. A unit of time is the time during which specific gains or losses are observed.
  2. A time span is the entire evaluation period consisting of individual units of time.

A day is one of the most convenient units for analyzing profit or loss indicators. A day provides the maximum number of observations at any time interval, which, in turn, affects the level of accuracy of the statistics. It is recommended to use a time unit of a week used if for some reason it is impossible to observe the desired statistics within each trading day. For the cryptocurrency market, which is open 24/7, this unit is the largest allowable one.

The scheduling of daily profit and loss indicators allows traders to analyze their cumulative profit and loss by means of a schedule. This process is optimized in the Portfolio developed on the Xena Exchange. The exchange automatically builds the PnL chart for the month. This analysis allows traders to quickly determine difficult periods, assess their scale in comparison with the general indicators, and use it as a basis for additional analysis. In particular, many minimum and maximum points on the profit and loss curve indicate that a high level of financial risk is characteristic of this portfolio.

Analyzing the profitability of trading sessions allows traders to identify the values of the PnL, which later helps them better assess performance and set adequate goals.

In his book Trading Risk: Enhanced Profitability through Risk Control, Kenneth L. Grant called risk management an investment:

“And here is my good advice for the future. The next time the ‘invisible hand’ of risk management finds its way into your possession, just do as I do in such cases — close your eyes and repeat many times over: ‘This is an investment. This is an investment,’ and wait until the income starts flowing.”