Maximizing Profits: The Power of Calculating Risk per Trade in Crypto Bot Trading

Introduction

Risk management may seem like a boring subject, especially in the world of crypto trading, where it is not commonly practiced. However, in this article, I will explain how per-trade risk management can help you increase your trade profits and lower your losses. I will also share my experiences and show you how to integrate risk management into your trading.

This article is meant for individuals who want to improve the performance of their trading bot, professional investors who need help selecting a trading bot with proper risk management, and traders who want to enhance their trades.

What is Drawdown?

First, let’s talk about losses. Drawdown is a crucial term in crypto bot trading. It refers to the reduction in account value from a peak to a subsequent low point, i.e., the decline in value that your account experiences during a losing streak. It’s vital to understand how much money you could lose before your bot starts making profitable trades again. The bigger the drawdown, the more capital you’ll need to recover from the losses and return to your peak account value.

For instance, if you start with $10,000 and experience a 20% drawdown due to losing trades, your account value decreases to $8,000. To recover your losses and return to the original $10,000, you’ll need to earn a 25% return on your remaining capital. As you can see, drawdowns can significantly impact your overall profitability in bot trading. Therefore, it’s crucial to monitor your account’s drawdown and adjust your risk management strategies accordingly to avoid excessive losses.

Telling the Future

When trading, it is important to know that you will not always win. You can lose, and you will lose a lot of trades down the road. In crypto bot trading, it’s about winning more than you lose; it is as simple as that. The higher the risk you take, the greater the potential reward. But remember, the higher the risk, the higher the potential losses and drawdowns can be. So now we know that using a portion of your capital per trade is a way to limit losses in a bad trade. But how much % of my capital should you risk?

This depends on multiple factors:

Your profit goals: How much profit do you want to make on a monthly and yearly basis?
Your risk appetite: How much drawdown can you handle?
How much profit does your trading bot make on average on a monthly basis?
What is the maximum drawdown that your trading bot experiences on a monthly and yearly basis?

An example

Let’s say you have a trading bot that makes an average monthly profit of 10%. You are risking 8% of your total capital per trade. The maximum drawdown during the past 5 years was 30%. On average, you can expect drawdowns between 20% and 30% every few months.

In this case, you need to rethink if you have the stomach for this kind of drawdown. Maybe you are better off lowering your risk per trade from 8% to 4%. Your profit would be a lot lower (somewhere in the 5% range). But the drawdown would also be lower, between 10% and 15% every few months.

Allocating a portion of your capital per trade

Knowing this, makes it logical to limit the maximum account you can lose. Let’s say you have $100000 in trading capital you could do that the following ways:

Using a fixed portion of your trading capital. For example $2000 (2%)
Using a variable portion of your trading capital in %. For example 2% ($2000)
I can imagine you are thinking, Jarno is joking, those are the same. Well, yes in the first trade the outcome of both are indeed the same. But when you are further down the line the variable portion in % makes a big difference. The compounding effect comes into action. Let’s write out 3 winning trades of 5% with a leverage of 20 for each method.

Fixed portion

• Trade 1
  Position size calculation: 2000 * 20 (leverage).
  Position size: 40000
  5% profit = 2000
  Capital after trade = $102000
• Trade 2
  Position size calculation: 2000 * 20 (leverage).
  Position size: 40000
  5% profit = 2000
  Capital after trade = $104000
• Trade 3
  Position size calculation: 2000 * 20 (leverage).
  Position size: 40000
  5% profit = 2000
  Capital after trade = $106000

Total profit in % = 6%

Variable portion

• Trade 1
  Position size calculation: $100000 * 0.02 (percentage of capital used)  = 2000
  position size: 2000 * 20 (leverage) Position size: 40000
  5% profit = 2000
  Capital after trade = $102000
• Trade 2
  Position size calculation: $102000 * 0.02 (percentage of capital used)  = 2040
  position size: 2040 * 20 (leverage) Position size: 40800
  5% profit = 2040
  Capital after trade = $104400
• Trade 3
  Position size calculation: $104400 * 0.02 (percentage of capital used)  = 2088
  position size: 2088 * 20 (leverage) Position size: 41760
  5% profit = 2088
  Capital after trade = $106488

Total profit in % = 6.48%

The difference in the total profit in only 3 trades is already 0.48%. Imagine the difference when you do this for 100 trades. The difference is mind blowing. If you are planning to trade for a longer period and want to use the compounding effect of the variable option, that is a good way to go.

Requirements for using % risk per trade while bot trading

If you want to use a fixed portion of your capital per trade, you need to know where your stop loss is before you enter your trade. Otherwise, you won’t know when to close your trade if the trade goes sideways.

I’ve seen many traders using fixed percentages for their stop losses. For example, “I’m entering a long position on bitcoin at $10000, and my stop loss is 2% lower, at $9800.” This can work, of course. However, when the market changes and gets more volatile, your stop losses could get hit very often.

A smarter way is to use resistance/support, EMA’s (exponential moving average), or ATR (Average true range) to place your stop loss. This makes the stop loss variable and adapts to the market situation.

Making the most of the capital you risk per trade

Now we know the following:

• Our entry: $10000
• Our stop loss (based on an EMA): $9900
• Our risk per trade (5%): $500
• What we do not know yet is our leverage. We could use our leverage to make our position bigger. You would calculate that like this: Risk per trade ($500) * Leverage (20) = $10,000.

So now we need to calculate how much we could buy for this trade based on our stop loss and entry. If we take a position of $500 (risk per trade) * 20 (leverage) = $10,000, we will have a delta of 1. If the price of the asset (Bitcoin) moves 1%, our Pnl/profit will also move 1% (more or less). If the price moves in the wrong direction to 9900, the stop loss will kick in, and our position will be closed.

In this case, we would lose 5% of the total equity. That is unfortunate, but the losses will be limited to that 5% only. Also, we used leverage to use the 5% that we use of the total equity to take a much bigger position, a position the same size as our total equity.

As you can see, this allows you to risk only a portion of your portfolio while being able to make a good return on your trade.

A simple way of thinking is this: the closer the stop loss is to my entry, the bigger the position is that I can take with the same risk per trade.

Trading Discipline

The example shared on calculating the risk per trade is pretty simple. However, trading is all about discipline. If you want to use this system, you’d better do this for all your trades. If you forget to set a stop loss once, your whole account could be liquidated.

In my experience, doing this manually requires discipline that not many traders have. That’s where trading bots come in handy. All these calculations can be automated.

My Experiences

When I started developing trading algorithms, I used a trailing stop loss but risked a fixed portion of the account in combination with leverage. For example, 5% of the total equity with 10% leverage. If the stop loss was really close, that worked fine, and the profits were fine. But if the stop loss was far away, this resulted in bigger losses than anticipated.

I’ve implemented the risk per trade where the crypto trading bot calculates the entry, stop loss, leverage, and used margin every trade. This resulted in a reduction of 50% in drawdowns, and the profits increased by 50%. Before I implemented this, I would never have thought that the impact would be so significant.

Conclusion

Understanding and using risk calculations are important and also almost impossible to implement on a structural basis as a manual trader. For bot traders, these methods can be programmed and automated. Use them to lower your drawdowns and increase your profits!