Transcription
Hello and welcome to another video as part of the technical analysis series. This is the first update to the series, and we'll be talking about risk management. The video first came out three and a half years ago, so I thought it's time to give it a bit of a facelift and a new pair of tits. Still as important as ever, but obviously my views have evolved and developed, etc., since then. So let's get straight into it.
Here's the outline for today's lecture, talk, monologue, lesson, general remarks. First, invalidation to follow. Once you've got those two, you can put together a basic conceptualization of stop losses. Having done so, position sizing and risk per trade is next, including the basic calculation and how to vary position size and when to do so, etc. We'll talk about some trade management tools, specifically in the form of dynamic risk to reward and Tom's evolving R, um, as well as break-even stops and partial profits, with some mention of winning streaks and losing streaks in between. And then a couple of, um, quick sections. They do need their own videos to some extent, but just to give them pay homage as part of a broader risk management guide, we'll gloss over leverage trading and cover some crypto-specific considerations before concluding.
Disclaimer: Pause it, read it, make sure you're familiar. I am an idiot. This is a joke. It's for entertainment purposes only. I'm not a financial advisor, not telling you to buy, sell, or do whatever with any of your money or your mom's credit card. That's it.
So, some general remarks. If you've made it this far, first of all, survival is the priority. If you survive your mistakes, that gives you a chance to actually look for alpha, look for an edge, or just become a better trader. Especially in crypto, it seems like the asset class disproportionately, in a good way in this context, rewards people who just simply stick around, even if they aren't the best traders or investors. So you need to stop hemorrhaging money first and avoid getting blown up by your experiments in the market so that you can eventually become profitable. So survival, always in first place, even as you get more developed and advanced, right?
Second point, as always, the video. This video will offer a basic framework, and the rest is on you. I'm not trying to give you some sort of copy-paste template to use forever. I'm trying to teach you, or at least guide your thinking and reasoning, so you can arrive at independent conclusions, thoughts about the market, frameworks, etc., on your own without me. So I think that's just more valuable in the medium to long term. If you disagree, there are a lot of videos that cater towards, uh, you. This isn't one of them. A lot of the quant guys were upset that my first risk management video wasn't particularly quantitative. Totally fair critique, but I just think that's not terribly appealing or attractive to the average person. So if you want the quant side of things, you're probably gonna have to look elsewhere. Mine is, you know, the premise of this video is to be accessible to the largest number of people, including those without a quant or math background. So just, just putting that out there now.
Colloquially, going back to survival, as long as you don't blow up, you have time to do two important things, right? First of all, figure out cool [ __ ] that has an edge. The way you do that is via experimentation, and of course, if you don't have any risk management, then those experiments simply cost your account, and that's the end of your trading journey, um, not very nice, right? And the second thing, of course, is by virtue of managing your bankroll, uh, it allows you to swing for the fences on really asymmetric setups. So very often, you'll find in crypto, it's, you know, a handful of trades that make up a very large part of your total P&L. And if your bankroll management sucks, and you know, you're constantly getting liquidated or managing terrible positions, etc., that really kind of ties your hands when it comes time to act in the most important parts in the market. Now, those two things together, very important: figure out [ __ ] that has an edge, and then really pedal to the metal where appropriate. So that's, those are the products of not blowing up your account and having some sense of longevity to your trading career.
Final point on that: never risk your ability to take risk, because at that point, the game is over. So don't, never put yourself in that position.
As for the last bullet point, it's just a bit of housekeeping. Although a lot has changed in the last three and a half years, my production quality and output hasn't. So we still have the good old format of Google Slides and me talking over them. Now, it's very easy to make like a 10-15 minute click-baity version of this video where I say, "Three risk management tricks banks don't want you to know," right? And then be like, "Number one, always make sure to use a stop. Number two, always make sure you've got two reward for one risk. Number three, always risk one to two percent per trade." And that's amazing, you feel like you've learned something, but the information is actually just surface-level, asinine dog [ __ ]. Right? And so that's not what I'm doing here. The point of this video is it's going to be longer, but we're going to get down to the very nitty-gritty of it, the, the gray areas, the detail, uh, so you actually can come away with something useful. Anything worth doing is worth doing properly, and that's kind of the premise of this video. If that's not appropriate for you, or you, you know, you're not geared to learn in this type of manner, uh, then I totally get it. But unfortunately, this is all I've got to offer, or fortunately, we'll see, I guess, right?
If you're still here, I guess thanks, and let's get straight into it. So we'll talk about invalidation first, right? Very important before you even mention stop losses. So the basic premise is that you risk money in the market, or you take a risk, or you take a trade because you have some sort of idea. Now, like all ideas, even non-trading ones, there needs to be, it needs to be falsifiable, right? There needs to be some sense of invalidation for when that idea is most likely, if not outrightly, no longer correct. So very simply, invalidation is when your idea is almost certainly, in brackets, wrong. It's just where you're wrong.
Let's take a step back. If your idea itself doesn't have an invalidation, it's probably worth reconsidering it. It's like holding any other views, right? Like I hold a political view, or like, you know, I hold view A on this public policy issue. It's like, okay, well, what type of evidence would make you reconsider that idea or say it's wrong? If you can't articulate the conditions under which your belief is wrong, then it's not a very rigorous belief in that regard, or at the very least, it's not reasonable. And it's very much the same in trading. If you have an idea, but the idea doesn't have invalidation, that's already a bit of a red flag or immediate sign that maybe you should spend a bit more time thinking about it, right?
Now, if we take a step back even further, if your idea doesn't have a basis in the first place, and you're just like, "Yeah, well, I'm long because the green button is, uh, brighter than the red one," then we have bigger issues, and it's all the way back to the drawing board. So the important parts, obviously, being having an idea and then deriving an invalidation from that idea. And that last bit is important, and that's the whole premise of the third bullet point: invalidation is usually a product of the idea itself. It's sort of built in to the trade idea.
What you don't want to do as a beginner is to take a trade for reason A and then close it for reasons completely unrelated to reason A. So, for example, let's say you're playing some sort of, I don't know, oscillator low time frame oversold bounce, and then you close the trade, and your friend comes to you and says, "Hey Steve, why'd you close the trade?" And then you say, "Well, because I saw this dog take a [ __ ] on my front lawn." So I closed the trade. Well, hold on, you took the trade because of an oscillator oversold signal. What on earth does a dog taking a [ __ ] have to do with that? And the answer is nothing. And that's how you know you're in the wrong neighborhood, right? In general, and there are exceptions to this, but in general, especially as a beginner, there should be a very clear link between the trade idea itself and the invalidation of that idea. If those two things are completely disparate, then you know something is likely wrong and worth reconsidering.
So, some examples for invalidation, what that may look like. You can have price-based invalidation. So the idea is that X level is support, and invalidation would be X failing to act as support. You can see on both sides of that equation, you have X either acting or not acting as support. That's a shared theme, and the invalidation is very closely linked to the idea itself.
I've also put in just a few time-based examples. So, for example, the idea is that price should consecutively close above X to suggest a breakout, and then validation would be price closing below X, and that's your typical kind of candle close invalidation logic. Again, the relationship is very clear: candle close above is the idea, invalidation is candle closed below, very closely linked.
Another time-based one: the idea is that price usually moves X percent within Y hours after Z takes place. Those letters, they're just placeholders, so you can put whatever you want there. Invalidation would be price not moving X percent within Y time frame following Z. Again, X, Y, Z on one side, X, Y, Z on the other side, not X, Y, Z on one side and sort of A, B, C on the other side. Again, very clear link between the idea and the invalidation. And, and typically with that type of logic, by the way, as it says there, it's one of those, "This [ __ ] isn't moving quickly enough for the type of setup it is." Invalidation. And also crypto, given all sorts of correlations with legacy markets recently, etc., you can get time-based setups and invalidations. So the idea that the market usually does X within Y, where Y is some sort of time period or trading session. Your invalidation is price not doing X within Y time period or trading session. So, for example, let's say you think the market is going to go up between, whatever, New York open and New York close. That's your idea. Invalidation would be the market not going up between New York open and New York closed. You don't just hold that position into the Tokyo open just to see what happens for the sake of it. Invalidation, always closely tied to the idea itself.
If you're gonna take anything away from this set of slides, or I guess this lecture as a whole, it would be that final example, just a kind of volatility-based one. You know, the idea is that price usually moves X percent within Y hours after Z takes place, and validation again, price moving less than X percent within Y time frame following Z. Both sides of the equation are kind of closely linked, and that's your typical, "I was expecting dildos, but I'm getting [ __ ] all." Invalidation, all the opposite of that, where I was expecting tiny candles, but all the candles are really big. Um, hopefully this section is clear. If you need to re-listen to it, do, because it sets the foundation. But the basic idea is, if you have an idea for a trade, the invalidation for that idea should bear at least some resemblance to the reason. So the reason you're wrong is very closely tied to the reason for taking the trade in the first place. You don't want to take two completely different things and say, "I'm buying because A, but I'll close it because E or Z on the other side of the alphabet, right?" There needs to be some sort of proximity between those two concepts, the idea and the invalidation.
Now that we have a working framework for invalidation, we can talk about stop losses. As, as it will be, as it will become obvious, not all trades have an obvious or outright stop loss, and it's sometimes less clear, specifically with the time-based or volatility-based examples. But of course, the opposite side of that is some price-based or TA-based examples will sometimes give you very, very clear invalidation where no thinking is required. So if that makes no sense, there is a video on the channel, I think it's titled something like "Overthrow for Stop Loss Placement," and that entire video is about the type of setups where you don't need to think about your stock placement and the market sort of does it for you. In those setups, it's not always the case, but it does happen from time to time.
So, what is a stop loss, right? So the basic premise is that the, a stop loss is an order, often, but not always, a market order to fully close a position at a certain price or at a certain loss threshold, right? Um, two types of market, the two most common types of market orders for stops. You either have a market order, which guarantees execution, often at the price of a less favorable, fuel price, or at the cost of a less favorable fill price. You're paying for the immediacy of execution, um, with inferior prices most of the time. Again, especially if you're executing large orders into empty order books or whatever, you know, things can get quite ugly. That's the basic premise for the market order: guaranteed execution, but the price you get may suck. Whereas with limit orders or limit stop orders, you know, if it skips your price and the market teleports, quite simply, you're [ __ ] because you're not guaranteeing that execution, um, at your price or as close as possible to your price. So the sort of TL;DR version ends up being that stop placement should be where either the setup obviously calls for it, so like in those TA examples where you have clear invalidation in line with the trade idea, or B, where the idea is obviously wrong if price trades to the stop order. And we will add some detail to that, uh, shortly. But those are the two kind of TL;DR scenarios. And you can see that if you don't have any sense of invalidation for your trade idea, it becomes very difficult to find an appropriate stop for that same idea.
And just to kind of go off on a very quick tangent, there's nothing wrong with saying, for example, that "I have a decent idea if you're making, say, a directional bet of where the market's going to go, but I don't have a particularly clear way of defining my invalidation for the trade, and therefore I will wait until such a time that I do." That is completely fine, right? Because again, those two things are very closely linked together: the idea itself and the invalidation of that idea. I mean, target is like a separate topic and slightly less important. I think idea and invalidation take precedence in that regard. So if one of those elements is missing, such as, you know, "I think I know where the market's going to go, but I don't have a clear way of setting up those trade parameters because I don't know where I'm wrong or invalidation isn't clear to me," it's completely fine to gloss over that trade for that reason. Sometimes the market just doesn't give you what we like to call risk-defined setups, and skipping those is fine, totally appropriate, right?
Now, a quick point about stops. The final bullet point: most of the complaints, I know I used 99 there, it's obviously a bit hyperbolic, but the overwhelming majority of complaints about stop hunting or the good old "price wicked and reversed on me," while it may seem sort of like intentional or engineered behavior on behalf of the market, on average, it's just not true. And more often, or better explained by simply having [ __ ] stop placement, not deliberate hunting. And we will talk about some remedies for that. But just maybe get that thought out of your head that someone's got it out for you. Um, most of the time, it's just your stop placement is [ __ ] and in areas where you should be looking to execute a trade instead of getting out of one in the first place.
Okay, more on stops. So, as before, stop placement is inextricably linked with the trade idea itself. Your stop reflects your invalidation, and we know that your invalidation is derived from the trade idea. If you have a [ __ ] idea, that typically translates to [ __ ] stop placement, most likely. Or, as we mentioned, sometimes you have a clear-ish idea, but because you can't define the risk on the setup properly, you may wish to, uh, skip over the setup, which is completely fine, right?
Now, if you don't know where to put a stop, that often means the idea itself was not defined very clearly, or the setup isn't particularly good, as we mentioned, right? That's appropriate. Now, a simple eye test you can apply to your stop placement is to just add the level on a chart somewhere. So maybe even a blank chart, like a separate line, and ask yourself, "Would I want to buy where my long gets stopped out?" And or, "Would I want to sell where my short gets stopped out?" If the answer is yes, then there's a good chance that the trade sucks, especially if you trade technicals, and maybe you should be looking to trade at your stop rather than exiting the trade at your stop. There's just like a simple eye test you can apply to give you some idea of whether your stop placement is favorable. And, you know, if it's completely wack, then maybe the trade idea itself sucks as well.
Now, the first top take of the video, in my view, and again, there are a million different ways to trade, so I'm trying to be, you know, capture a lot of those methods in this video. So here's my view: strictness with stop usage and placement is inversely correlated with the size of the move you're trying to trade. Now, what does that mean? Let's use some examples. If you're punting these low time frame tight rotations with nearby invalidation, which typically also means a lot of size, your stop placement needs to be strict because the idea must be precise to be correct. And then obviously, the opposite is true. If you're saying, like, "No, I think the market's going to bounce between 38k and 42k," or whatever, uh, especially if there are kind of liquidations or like a big move coming into the level, because you are, your trade idea must be less precise while it's still being able to be correct. Your stop placement, in turn, can also be less precise or surgical or less tight in those circumstances.
So the summary version: if you're being precise with the trade, your stop placement should also be precise. If you're being less precise with the trade, or dealing with a wider area or a higher time frame idea, your stop placement can also be less precise or wider. Make sure to not mix the two, because that's when you get really shitty trades. I.e., low time frame trades with a lot of size and really sloppy stop placement, which exacerbates losses, or high time frame kind of swing ideas where you should be giving the market, kind of, a chance to breathe and develop structure, but instead, you're on the one-minute chart trying to put a stop order under the first swing low or swing high that you see. As long as you avoid those extremes, you're fine. But just have this kind of framework in your mind that your stop placement should, to some extent, reflect the type of trade you're taking. More precision with the trade equals more precision with the stop, and then sort of less precision with the trade, generally less precision with the stop, because you have either a narrower invalidation if you're doing the low time frame, higher size stuff, or you have a wider invalidation if you're doing the swing trading type of model. And that reflects in your stop placement. I hope that makes sense.
Now, in terms of types of stops: hard stop and soft stop. What is a hard stop? Well, in essence, it's a market order to close the full position at a certain price or loss threshold, right? Um, when is it appropriate? In my opinion, it's best used for clearly defined setups and or setups where entry is close to invalidation, which usually means more size, as we'll discuss as well. So the hard stop is essentially your eject button from the market.
Now, soft stop. It's a kind of mental stop to start closing out the position, um, typically using a mix of limit and market orders if, in, if and when invalidation criteria begin to be satisfied. And again, this is more suitable for your kind of swing tradie and ideas that are less reliant on precision. So, for example, let's say your basic premise was that the market with, you know, say, BTC bounces between 38 and 42k, just pulling numbers out my butt here, and the market pokes above 42 and then closes back below it, and it kind of looks like resistance. Then maybe you start exiting that trade or scaling it down as the probability of a bounce from that area, um, starts to lower as it acts as resistance, as a very basic example.
Now, as a beginner, this is where some different practical recommendations come into place. In my view, you should just use hard stops if you're a beginner, because, I mean, the likelihood that you mess up your order placement and using the UI/UX, whatever, of the exchange, that's probably going to happen to you, which is fine, it's part of learning. And also because your ideas probably suck. That's not necessarily a bad thing, because having those sucky ideas and getting stopped out and then watching the market like mega reverse without you or whatever scenario you may come across that, in itself will teach you more about stop placement than anything else, just by studying what the market does if anything after taking you out. And it's very often with beginners where their stock placement is pretty horrendous, they keep getting stopped out at the bottom before a move up or the top before a move down. And, and by virtue of kind of studying their stops, that leads them to identify better trades by trading at where they thought they should be getting stopped out instead of exiting the trade at that point, right? So there, there's definitely valuable information and valuable lessons to be learned from getting stopped out, and it can actually lead to some pretty good trade ideas as well. But in general, because of the likelihood of error when interacting with the exchange and just in general because your ideas probably aren't that great, um, soft stops just require more experience and knowing the type of setups you're trading, etc. As a beginner, I think hard stops are your friend, and you can branch out if, if appropriate.
Do read Adam's blog in its entirety, but also over at Trading Riot, the risk management blog. Um, it's a comprehensive guide, and specifically, it's got a very cool section on using soft and hard stops and for a variety of setups, pretty creative stuff there. Go, go check it out.
Okay, so now that we know invalidation and we know what what a stop order is, we can talk about position sizing and risk per trade. So definitions first. Position size and risk per trade are two different things. People get this confused all the time. They'll see, like, "Oh, you know, someone tweets like a one million contract position size," and they'll think, "Oh my god, you know, if he's wrong, he'll lose a million dollars. How rich is this guy?" Uh, that's not the case, right? We're dealing with two really quite different concepts.
So, what is position size? It's the number of units of an instrument bought or sold, right? Just the number of contracts for a position or whatever it is that you're trading. The risk per trade is the percentage of your portfolio, or just whatever the notional amount that a trader stands to lose upon invalidation, slash if their stop gets hit. Now, obviously, that number isn't going to be perfect because they might manage the trade, or the actual execution of their stop order might suck, and they'll lose more if they get a bad fill, etc. But fundamentally, when it comes to basic definitions, position size: number of, the number of units of an instrument bought or sold. Risk per trade: is if I get stopped out, if my idea is wrong, how much do I stand to lose, not accounting for execution and other stuff?
Now, as you can derive or infer at this point, if you have an invalidation point, calculating your position size becomes rather straightforward math, right? So here's the kind of basic formula, I suppose: your position size is calculated by multiplying your portfolio by your risk percentage and then dividing that by the distance to your invalidation from your entry, right? So, just to define those terms: your position size, again, is the number of contracts if you're using like perpetual swaps, for example, or whatever else. Your portfolio is your total trading capital or equity, right? How much is in your trading account or whatever sub-account you're using. Your risk percentage is the percentage of your portfolio at risk, expressed as a decimal, again, how much you will lose if you get stopped out, not accounting for whatever additional execution costs. And then the distance to invalidation is the, again, rather simply, the distance between entry and invalidation, expressed as a decimal.
So, let's take a very simple example. You've got 100k equity, risking two percent on a setup, so two percent of the hundred thousand. And your invalidation, or your stop, is five percent away. Um, the math is pretty straightforward. Again, position size equals portfolio times risk percentage divided by distance to invalidation. We plug in the numbers: 100k is the portfolio, 0.02 is two in decimal form, and we divide that by five percent in decimal form, which is our invalidation. And that gives us a 40,000 USD position size. And you can always check the math. If we take that 40,000 USD position size and it moves five percent and hits the stop loss, you get 40,000, so five percent of 40,000 is 2,000, which appropriately is two percent of 100,000. So all in order, as per the criteria. And again, just to reiterate, this doesn't account for slippage, fees, etc. I'm mostly assuming you're trading liquid markets and liquid sessions, sufficient order book depth, and all that other good stuff.
Okay, that's kind of the basic math there. Here's the spicy part now. Most risk management guides are understandably just casually very conservative and will tell you to risk anywhere from 0.5 to whatever, three percent, uh, of your account per trade. And the reason they do that, again, is completely understandable because your risk of ruin, or the chances of blowing up your account on a consecutive losing streak at those conservative positions, or percentages rather, is quite low. So if I had to follow that framework and say, kind of, a gun to my head, one to three percent, uh, of your account per trade is safe. But just to be very clear, that range is useless without context. And in general, fixed risk per trade is mostly [ __ ]. And that should be kind of immediately evident by the fact that it assumes that all the setups carry the same expected value. So all yours, all the trades that you take, all your setups are somehow equal, and therefore they should be treated with the, um, same sizing or same risk. And that just doesn't sound compelling, right? I'm sure even you can imagine some things, some setups that you have or trades you like to take work really well and offer you really handsome win rates and high risk reward, etc., etc., while others are kind of awash. So it kind of fails the basic eye test to risk the same on setups that you know have an edge and work really well, and setups that kind of suck and are a bit of a coin toss at best, right? It just doesn't really make much sense.
So, two things to consider. So, how much do I risk per trade, um, given that I think there are two factors that that should inform that decision? The first is, what is the expected value? The EV, if you will, which is simply just means average outcome of this specific setup, right? And then the second point to consider: what are the chances of ruin? As in, blowing up your account if you eat [ __ ] on this setup repeatedly. So that there's like a very, again, discretionary type of framework to this, which I think is better than giving you arbitrary percentages. And this is how I think through it.
So, if you're dealing with frequent setups with marginal odds, that warrants marginal bets. What's that in colloquial terms? It just means risk less on [ __ ] that happens a lot and has a marginal edge advantage in the market, right? And obviously, we're dealing with a bit of a scale here. Then, if you have frequent setups with good odds, that typically warrants bigger bets. And the colloquial version: risk more on [ __ ] that happens a lot and has a clear edge. This should start to become quite intuitive as I go through it, right?
Now, obviously, the less, less frequent setups with great odds generally warrant the biggest bets. And it's sort of the risk most on [ __ ] which rarely happens, but offers a massive edge and a no-brainer type of scenario. Now, it's very likely that you have different setups in your trading arsenal, uh, appropriate for different market regimes and whatever. So it just simply doesn't make any sense to, you know, if you're betting one percent on your once every three months best performing setup, but then also betting one percent on the day trading setup that comes out two, three, four times a day. It just doesn't stand to reason, right? I mean, even if you consider different types of trades, if you're day trading, like, I don't know, five, ten, fifteen trades a day, depending on how many rotations you're getting and the size of those rotations, risking, you know, a fraction of a percentage on those setups could be reasonable and lands you at a decent daily risk limit, right, depending on your win rate and other things. However, let's say you've got like one complete banger setup which comes around in the market once every two, three months, and then you risk one percent on that setup. That just doesn't make any sense. It doesn't stand to reason, right?
So again, I sort of semi-apologize for not giving a lazy percentage answer, but this is the reality of discretionary trading, right? You consider the individual expected value or odds of specific setups, you consider the frequency with which that setup occurs, and then that gives you a sort of spectrum, right? So on the left-hand side, in terms of risking less, you have high frequency, low EV [ __ ]. So those are setups which are meh, and therefore warrant, you know, reduced risk, if, if any risk at all. They happen all the time, the edge is kind of questionable or marginal, there's nothing special about them. And on the other side of the spectrum, you have setups that are far less frequent, but with like a really big win rate or positive expectancy, or just high EV, kind of an umbrella term for all those things. And in that case, and that's the other end of the spectrum, which is really good setups and warrant more risk, right?
Just a very quick note for the obvious outlier: if you have high frequency, if you find like a high frequency, high EV edge, that's kind of the golden goose of trading, and it's very likely that it's some low time frame short-term idiosyncrasy that's probably not going to be in the market for very long. If you see that, absolutely [ __ ] smash it, and then bin it as soon as it stops working. And that's sort of where this last point comes from. Um, the best edges don't last long enough to be back tested thoroughly. So if you think you've stumbled upon a high frequency, high EV setup, just milk it while it's there. Just be very, um, aware that as soon as that stops working, it's likely going to not be an edge at all. You kind of milk it, and then as soon as it breaks, you don't try to force the issue. Um, so that's really it when it comes to position sizing and risk per trade, right? It's a spectrum. On the "don't risk much if anything" end of the spectrum, you have stuff that happens a lot and stuff that has marginal odds or EV, not very attractive. On the other side of the spectrum, which warrants more risk, is the lower frequency setup, but, you know, you're in for a treat, and those setups warrant more risk. If you stumble on the golden goose, high frequency, high EV, slam it, and then it's on you to pass your trading, figure out the types of setups you trade, how frequently they happen, what's their expectancy or expected value, and then decide your risk parameters from that point. There's no right or wrong answer, it just needs to be a considered decision based on those factors: the frequency of the setup, the its expected value or average outcome, and then the risk of ruin if you trade it at a certain size.
The brain-dead summary version is: bet less if anything on meh odds, and bet more with higher conviction on lower frequency, good odds. That's what it comes down to, because the alternative of course doesn't make any [ __ ] sense, to be clear, right? If you get fantastic setups that come up only once every one, two, three months, just like a complete brain-dead one, and you risk one percent, you're not really optimizing your trading. And in the same vein, if you get this day trading setup that comes up 10 times a day, and you just pick one of those 10 times and risk 10, that doesn't make any [ __ ] sense either. So that's why I'm building you this kind of spectrum to consider where your setup exists on that spectrum and to risk, um, in a more tailored way to better reflect the circumstances.
Okay, so let's dip into trade management very quickly as a facet of risk management. We're gonna talk about dynamic risk to reward, or Tom Dante's evolving R, as I'm sure you remember from the first video. Uh, so the basic premise of evolving R is that the risk to reward ratio of a trade evolves as price moves away from from your entry point, either to your target or even to your stop. And the basic idea is to make sure you're not being complacent in trade management. So we'll have a chart example here in a second. Let's say you buy at 50, target 100, and stop at 25. So you're risking 25, 25 for a gain of 50, that's 2R, okay? So the scenario we're about to cover is that fourth sub-bullet point is that suppose the market pushes from 50 to 85 and starts to struggle, right? Let's, let's display that.
So again, TradingView standards, the middle bit, the middle line is your entry. This is your take profit, and this is your stop, right? So let's posit that you have, um, at the po, at the point in which you open the trade, which is here, right? This is your entry, this your stop, this your target, right? That's a two R trade. Now, let's say the trade has evolved, markets moved around, and it moves, it's moved up to this 85 handle and then starts to struggle around it. Maybe it puts in a bearish divergence, some broken market structure on low time frames, whatever. If you haven't moved your original stop, it's still at 25, as it was in the original setup. But now the market's moved all the way to 85. Considering your target was 100, you can see that the risk reward of the trade shifts because now, despite your original entry being at 50, the market's now at 85. This difference between 50 and 85, it's still unrealized P&L, it doesn't mean [ __ ]. You haven't made any money on the trade. So now, as the market starts to struggle with this, let's say it's a resistance or some sort of like other contextual level, you need to reassess what type of trade am I in now? That it's moved in this context at 85, you are risking all the way back to your stop in order to capture these extra 15 points. And that gives you, at the time of reassessing the trade, 0.25R. So at the inception of the trade, you have 2R, right? Gain two units of reward per unit of risk. Then, as the market comes into this level and starts to struggle, provided you do no trade management and you just sit there, the adjusted risk to reward of the trade at the time that it's actually moved drops drastically to 0.25R, okay?
Now, there is some nuance here, unsurprisingly. So evolving R posits that where appropriate, you should reassess the risk to reward calculation, uh, to, you know, to figure out if staying in the position is justified. In the absence of any management, in the example, as we mentioned, if you do nothing, that trade has become an evolved 0.25R. You're risking 60 points to gain another 15 at an area where the market appears to be shifting. Now, look, I know that 0.25 is a lot worse than 2, but the point of evolving R isn't to ensure that your trade always satisfies some arbitrary ratio, like, "Okay, the trade was 2R, now it's 0.25, you know, 0.25 isn't 2, so I should close the trade immediately." That's not the point, right? It's there to serve as a kind of wake-up call, um, or trade management signal. Once the market approaches your take profit, it's just to keep you sharp and to reconsider the context as the market starts to approach your pre-existing trade parameters, be it your take profit or your stop. Of course, what's implicit in this idea is that there's nothing particularly special, as we'll come on to, about your take profit or your stop level or whatever it is that you're using to anchor the trade, nothing, you know, implicitly, um, important about those factors. So what evolving R does is just to make sure that you kind of stay sharp and manage trades and pay attention to the adjusted risk to reward in areas where it makes sense to do so, or as the market starts to turn before your target or before your stop.
Two final points on this which are important. First is the best guide here will be your trade journal, and that's looking at whether on average, your trade management decisions improve your results, or if you're better relying, better off relying on set and forget, right? Now, with evolving R, people who take this concept on board, take you usually kind of veer to one extreme whereby they will never hold a trade to target and they will never be fully stopped out, and they're always looking for management signals to kind of do something with the trade before it reaches their parameters. That's not the point here, right? As per the last point, the emphasis should be on making sure trades that are near completion don't round trip and come back to stop you out. So let's say you buy 50 with a target at 100, the market gets to 95, and then you let it come all the way back to stop you out. It's that type of [ __ ] that's unacceptable, and is the premise of evolving R to make sure you don't give back extremely unreasonable, um, setups to the market, right? Or forego a disproportionate amount of profit for just an extra tiny bit of a reward.
Now, just some notes on how trade management usually works in early stage trading. I think two points that I make there are correct in my experience. So beginners are usually better served learning via conservative targets and set and forget. So conservative targets just mean like FTA or the first trouble area, as per the other technical analysis series. And by set and forget, I simply mean having a pre-existing entry, target, stop, and not really doing much in between unless there's an overridingly compelling reason to intervene. And as a beginner, your instincts for when to intervene are probably going to suck. And at least with set and forget, you'll have some good data as to whether the market reaches your target, are you being too ambitious, are you being too conservative? I'd much rather have that consistency than, uh, non-kind of evidence-based interventions in the market based on your emotions, right? And that's where the second point comes from: the early on in your trading career, purely probabilistically, you're far more likely to overmanage a trade, uh, than undermanage it.
So that's some quick stuff on evolving R. I know I covered it in the first risk management video to some depth, but people mistook that to say that you should always do something ahead of your take profit or before you get stopped out. That's not the case. I think the primary emphasis should be on not giving back massive gains when the reward left is tiny, and, and vice versa. It's just a bit of prudent, active, non-lazy trade management is the core premise.
Now let's talk about winning streaks and losing streaks. So by definition, a streak, as the name suggests, is consecutive wins or losses in the market. Now, streaks can offer information about changes in the market regime and or the expected value of a specific setup. Again, expect value, average outcome, whatever. I've broken this down into two, uh, rather straightforward sections: dumb [ __ ] to avoid, and smart [ __ ] to consider.
So on the dumb [ __ ] to avoid side of things, here are some really common mistakes and things you shouldn't do in my opinion. First of all, risking more when losing to make it all back. That should be intuitive, but that's how you dig a hole that's hard to come back from, um, especially if the specific setup is losing more often than not. That can be some sort of sign in the market that conditions have shifted or the edge is over, or what be it. So if your setup is not working, risking more to make it all back, if anything, the probability is that you dig yourself an even deeper hole. Not worth it.
Another bad idea is risking more on losing setups while other setups are doing well. This is specifically especially the case if you have setups which are contingent or reliant on different market regimes. So if your trending setups are printing, but your ranging setups are losing, and you start betting more on the ranging setups, kind of because they are losing or you think there should be some sort of parity between setups or whatever, that's a bad idea. Don't do it.
Another one: risking less when winning to accumulate karma points from the market for not being greedy. This one is really stupid, right? And it's really presumptuous because if the market's rewarding your style of trading, that's probably almost certainly not going to stick around forever. So if anything, the most you can do to maximize your expected value or your expectancy as a trader at that time is to milk the edge while it exists. So you often see people, "Look, I'm on a win streak, I'm gonna back away and kind of chill out." I think that's wrong because you never know when the next time will be that those conditions become favorable towards your trading system. You're almost duty-bound to make the most of those conditions and trade them while they're there. There are no bonus points for being like, you know, "I've done really well, time to take a step back," etc. If anything, you don't know if or when the next time you're going to be able to trade well will come about in the market. So make the most of it while it's available. Your fake humility will not be rewarded by the market, right?
Bad idea: risking less on winning setups following a losing streak on a different setup. Now, this is why having clearly defined or at least somewhat defined setups is important because again, they will often rely on different market conditions, regimes, etc. Now, what you see when people hit a losing streak with a certain setup is they feel the need to kind of reduce their risk management, sorry, increase their, sorry, reduce their risk per trade in general and say, "Yeah, I've lost three trades in a row, I'm just gonna back away a little bit." It's like, but mate, your ranging setups are eating [ __ ], sure, but your trending setups are completely printing. Why would you back off the stuff that's working just because some other stuff isn't working as well? So that, that's why having setups is so helpful because you can, you don't need to completely back away from the market in a losing streak. Maybe just one side of your trading isn't working, and it's time for the other to shine. But just because you take a beating in one style of trading doesn't mean you have to bin everything and kind of take some time off or do whatever, assuming you're still following your rules. I mean, obviously, if you're tilted and doing dumb [ __ ]
] Then maybe you should take some time off. Um, this last one happens a lot. Ditching a profitable setup after a small string of losses? Just don't do it. It's probably a setup in your system because it's done well over a large period of time. There are lots of reasons for why setups don't work, which we'll talk about in a moment, and ditching a profitable setup after a small string of losses is just a bad idea. Um, you're making quite big decisions based on short-term or incomplete data, and that generally doesn't yield the best outcomes.
Now, what are some smart things to consider? So here are a few. By virtue of having your setups defined quite clearly for different market regimes or instruments or time frames, or however you want to split them up, you can simply make the assessment which setups are working well and which ones are no longer working. And from there, provided you have enough data, you can start to make some inferences about subtle shifts in market structure or conditions, the type of regime we're in. So, for example, if trending setups start losing and ranging setups start printing, then that could give you a hint that the market is changing from a trending regime to a ranging one, right? And then that, in turn, informs you about which setups to add more risk to or trade more frequently versus which setups to maybe back away from, right?
Now, again, if something is working well, you don't know how long that's going to last for, but you should take advantage of it while it's there. And that usually means you either trade it more frequently and or with bigger size. I generally like to just trade it more frequently. The whole bigger size argument can get a bit tilting. If you think an edge just started working well, you win one or two trades and you add size, and that trade is a loser. It tends to be a bit funky. So I think if a setup is working well, I think both of those are fine, but in general, trading, at least start by trading it more frequently before considering, uh, size adjustments.
Now, if something is not working well, obviously, you know, the opposite applies. Trade it less and or with smaller size and or be more selective with it. That last one is really important. Um, if a setup, you feel like a setup is losing edge or hasn't been as clear recently as it has been in the past, one things you can do is, one of the things you can do is to essentially apply a quality filter to it to say that this is what the setup looks like in its A+ ideal form. It's kind of not been so great recently. I'm only going to trade the really clear, outright examples of it and not the marginal cases. That's just one, one way to, to filter out or to filter for higher quality trades.
We touched on this earlier with short-term edges, but if you have a novel short-term edge that stops printing, you should probably bin it because those sorts of short-term idiosyncrasies don't, don't usually come back and it's more, more or less like an on and off switch. So, for example, if there's like heavy selling at a, in a certain exchange at the start of the Asian session over the period of like a week, and then suddenly the flows flip and that session starts buying, don't try to keep cramming that edge once the behavior is quite clearly shifted. Especially for this low time frame stuff, it could be as, um, you know, as nuanced as following a specific algo or a specific whale or participant, whatever. As soon as that stops working, those aren't the types of edges that you should, uh, force past their expiry date. So just something to bear in mind there.
If you find something, milk it. As soon as it stops working, bin it. Um, those short-term edges sometimes are the best sources of profit, but also need the most discipline in execution. This last one is really important. Uh, short-term streaks don't necessarily mean a setup is trash or fantastic. There are a bunch of reasons. I mean, the whole point of trading is that you can do the quote unquote right thing, the plus EV thing, and still lose money, right? In the same vein, you can do the wrong thing and trade like a dumb ass and still make money. So if your brain isn't process-oriented and thinking about sort of large numbers and the next kind of fifty, hundred, hundred fifty thousand trades, whatever, um, maybe try to recalibrate in that direction.
And just quick, very quickly, some of the reasons why setups fail or succeed and that might not be most indicative as to their long-term expected value. You sometimes just get variance. That's part of the deal. You might be incorrectly identifying setups, which leads to better or sometimes, sorry, worse or sometimes even better outcomes. Shifts in conditions again, that awkward phase where you're in a, you've been in a range, your ranging setups have been printing, then suddenly they stopped working and your trending setups are making money, but you're not trading and trading them yet because you think the market's in a range. So those, that sort of awkward lull where you're identifying the shift in conditions, but your actual trading hasn't caught up yet, uh, that can be a reason for setups working well or poorly.
And then the last one, which is a sort of very apt summary of all those conditions, [ __ ] happens. [ __ ] happens. So don't read too much into it. Think about the next 10, 20, 50, 100 trades, etc., depending on your trading style. But [ __ ] happens is definitely an important one. Last point on streaks is just to be nimble. Some variance is expected, but if you're going to gain anything from those streaks, I mean, first of all, don't tilt and blow up and just assume I should stop trading and any of that type of stuff. Uh, be analytical about it. But in general, um, you should really strongly consider whether the streak, be it a winning or a losing one, is telling you anything about market conditions. So if you have staple setups that print money, like if we're in a range, this setup always does well, or if we're in a trend, this setup always does well, and suddenly they stop doing so well or underperform or whatever, you know, incur a losing streak, sometimes that will be very useful and actionable market information.
And all of this is impossible to do without a trading journal. I don't mean anything sophisticated. Even just a Discord just with you, which has a few of the setups you trade and then you track your trades, that will be sufficient for these purposes. So TLDR, there's dumb [ __ ] to avoid when on a streak. There's smart [ __ ] to do in the aforementioned list. The thing to look out for is it's very unlikely that everything you do stops working. See where the odds have shifted and what clues that gives you as to the larger market conditions. Be prepared for stuff to suck from time to time and writing it off to variance. And if you are fortunate enough to be in a condition or to be in market conditions where your setups are doing really well, make the most of it. There's no, there are no points for this fake humility.
Right now, back to trade management. Very quickly on break-even stops and partial profits. I'm sure you've heard these gems, so-called gems of trading wisdom before. That stop to break even, you know, I've got a free trade now. It's [ __ ]. It's not true, as we'll discuss. And the cousin of that trading idiom, uh, which is, took some off here, can never go broke taking profit, also not true, not compelling for reasons we are going to discuss now.
Okay, so here we go. Just being very real with you here, and I think you know this deep down if you search your soul. Most break-even stop and partial profit decisions are made to achieve psychological comfort, not because those decisions improve trade outcomes in the long run, right? So just like we said, really early on in the beginning of the video, there should always be a clear link between your trade idea and your invalidation, right? So it's kind of thesis-driven. When you move your stop to break-even, most cases, that's not thesis-driven and it has actually no bearing on the reason you took the trade in the first place. Actually, it's just an arbitrary way to avoid dealing with the inherent uncertainty and chaos that comes with markets, right? So there's nothing special, as we alluded to earlier, about your specific entry, target, stop loss, you know, your P&L, the price at which you can afford that new watch or do whatever else. The market doesn't care about any of that, right? So making decisions to preserve the sanctity of those arbitrary figures is a futile attempt to impose your will on the market. That's just all it is, right? And it's kind of a disrespect to yourself to some extent, saying that, well, I'm taking a trade because reason A, and you know, I've, it's back-tested and I've got a thesis and it makes sense, and then you make an important trade management decision like moving your stop simply because you like the amount of green P&L you see or you're scared to go underwater again. It's pure psychological cope as opposed to process-driven decision making. And that's kind of the, the whole point of the first bullet point with break-even stops is that trade management decisions should never be arbitrary and should almost always be derived from the trade idea itself. Uh, putting a stop at break-even because you quote unquote won't lose any money is the definition of arbitrarily tampering with a live trade.
Now, the argument most advocates fall back on is that you take the risk out of the market and it's a free trade. If we think about that critically, we know that that's not true, right? Because the cost of moving your stop to break-even is sacrificing the potential gain you could have had from your trade idea, but is that, is no longer accessible to you because you're not letting it play out properly, right? So think about it, even in purely TA terms, your break-even stop on a long is essentially saying, I am bearish in the same place that I bought previously. And we could even do like a ghetto diagram of what that looks like. Let's say this is level of support, right? Market comes in, you buy it, it bounces, and so you decide to put a stop at your entry, right? Or at around your entry. So you put a stop here. Now, as the market comes back, you know, normally you get a bit of a kind of mechanical bounce first time around before the market sort of revisits. As the market's coming back into this level, this is still support, and you were happy buying it moments ago on the, on the premise that this is an area where the market might reverse. Now, bear in mind, if you're long, your stop loss is going to be in order to sell, right? So if the market pushes back into support, what you're doing by definition is selling where you bought previously. Does that make any sense? I mean, in some cases, maybe, but that's the exception to the rule. What you're really doing is saying, I don't have conviction in this trade, or I don't have the balls to deal with markets, so I just want the market to go up in a straight line and make me happy immediately. If it doesn't, somehow the thesis is incorrect. But, but we all know that's [ __ ]. So what is it? Once you, you know, the emperor is naked type of thing, it's clearly just a coping mechanism. There's no good, most of the time, there's no good compelling reason to want to sell where you bought moments ago. Nothing's really changed by this retest, right? Except you have this magic unrealized P&L, shiny numbers and green stuff, and you don't want to be underwater because you have PTSD from other trades and a bunch of other non-compelling explanations for that type of behavior. It, most of the time, it's [ __ ] and you know it, right? So break-even stopping along, as we discussed, I'm bearish in the place that I bought previously. Most of the time, that's not a plus CV decision. And the same works for shorting. You know, I'm, if you put a break-even stop on a short, I'm bullish in the same place that I sold previously. So to preserve, quote unquote, preserve your P&L, you are happy to sell support and buy resistance so that you don't have to sit on the water for a bit. Maybe does that sound like good long-term trading habits? I don't think so, right? My view is that no is the answer.
Now, look, I'm not a complete extremist with these things. Sometimes it will be true and reasonable. But if the market, you know, especially if you get like very dislocated entries or crazy wicks or in certain contexts, it is very much the case that if the market retests your entry, the idea or the probability of your idea being correct falls drastically. That's per the bottom bullet point. It can be justifiable where revisiting the entry invalidates the idea or makes the setup very likely to fail. But I'd be willing to bet nine times out of ten when people put a break-even stop on a trade, it's not a considered opinion based on the new price action evidence or whatever metrics they track. Rather, it's just a coping mechanism for, well, at least I won't lose money. Well, you know what? You won't make any either in the long run by not letting your ideas play out. Have some balls, trade the setup and not the P&L.
That logic is unsurprisingly applicable to partial profits as well. It can be justified in search certain situations like the evolving R examples. But arbitrarily closing trades based on non-market factors like P&L alone will likely harm you in the long run. Okay. And as mentioned, trading is process-oriented. So let's consider, um, the cost to this type of arbitrary management. So my view, as per the middle bullet points, is that there is always, there's no such thing as a free lunch or a free trade or any of this type of stuff. If you cut your trades early at break-even, in the long run, you probably perform better by letting your setup logic play out. And the same for taking profit early, in the long run, assuming it's arbitrary, of course, not like an evolving R example. But in the long run, you probably perform better by letting your setup logic play out as well.
Now, look, let's play sort of devil's advocate here and steel man the other side of the argument. Even if it's not true that in the long run you, you perform better by letting your setups play out, if you manage your trades according to a system or somewhat objective criteria, you at least have data. You have evidence that you can review and optimize your trade management. However, if you're just randomly closing trades, so putting your stop a break-even because you don't like being underwater or immediately taking profit when you see some sort of P&L that's like a month of rent or your favorite meal deal from Boots, Tesco, whatever, those decisions don't give you any useful or actionable information. So even in the best case, if closing these trades early isn't harming you in the long run, you still can't do anything with that. You can't optimize it because the decision process itself is arbitrary. In most cases, there's [ __ ] all you can do to, to make your trading better from these arbitrary on and off switch flicks, right? So even in the best case, if it's not harming you in the long run, you can't do that. That type of decision making doesn't lend itself well to being optimized, studied, streamlined, whatever. But in, in fact, the worst or base case for this is that closing early is harming you in the long run, and the decision-making process is too arbitrary and opaque to be helpful. Okay. There's just some my views on that matter. I suppose the colloquial or slightly rude version of that is, it's unlikely that I close winning trades when I feel my dick tingle is an edge. Very unlikely, right? So if you're going to commit to trading, you have to commit to being process-oriented. And that process should be open to scrutiny and based on certain principles that you can kind of tweak, revisit, readjust, whatever. If those principles are, I put a stop at break-even because I'm scared of being underwater, and I close my trades early because I like the green P&L, what, what the [ __ ] are you supposed to do with that? It's arbitrary. It doesn't let your own conviction and trade ideas play out, and it's very hard to do anything with in terms of optimization down the line.
Leverage trading, as I mentioned, this probably needs its own video and I'll try to make that happen at some point, maybe. But just from a basic risk management overview, here's, here's the summary version. Now, leverage trading, as I mentioned in the first point, it's not evil, but it's not a shortcut either. It's just like a tool, like any other. If you misuse it, you get hurt. Some people do very well with it. I will say that most, for every kind of leverage success story you see on Twitter or social media elsewhere, there are thousands, tens of thousands, hundreds of thousands who just lose all their money. Leverage trading. So be aware of the social media highlight reel that is being presented to you.
Now, what is the basic premise of leveraged trading? Well, you can put on positions with a fraction of the notional amount of the position you want to trade as collateral. So let's say you have spot markets, right? I want to buy $10,000 USD of coin A. I need $10,000 USD because otherwise I can't buy $10,000 USD of coin A, right? Now, if you're trading leveraged products, uh, and you're trying to put on the same position, you can offer a fraction of the position you want to establish as collateral and then you borrow the remainder, quote unquote, from the exchange. So I can have a fraction of $10,000 USD in the same example, um, and with $5,000 USD in my account, I can put on that $10,000 USD position by levering my $5,000 USD two times, okay? So it's essentially a form of a loan or borrowing money.
Now, obviously, one of the primary risks, kind of like with any other loan, uh, of leverage trading is getting liquidated. And liquidation is when your position is forcibly closed by the exchange when you run out of maintenance margin, so you don't have enough collateral to keep the position open, right? In effect, there are two types of liquidation. It's either your position gets closed, that's isolated margin, your collateral is kind of, it's the collateral isolated to that specific position. Or in the worst-case scenario, and unfortunately in many cases, the default setting, uh, for trading futures or trading with leverage, whatever, is cross or portfolio margin, where your entire trading account becomes collateral for the position. So if the position is forcibly closed, uh, you lose all the money in your account because that was the collateral base, okay? A gross oversimplification there, but that's what you get in there. We've already been going on for an hour, so we'll have to deal with it.
Now, if there's one thing you learn from this whole leverage thing, it's the following. Cranking up the leverage slider does not increase or decrease your P&L. Your P&L is dictated by your position size. This is really important. So someone will say, oh, should I use 5x or 20x? Well, it's a nonsensical question because your P&L is going to be dictated by your position size. Leverage merely affects how collateralized you are for that position size, right? So let's take a very basic example. Buying 10,000 contracts of a linear altcoin USD future at two times leverage. The market gains 5%. That's a 5% gain. And then if I long 10,000 of everything, the same at 10 times leverage, right? It's still a 5% gain because in both cases, I'm gaining 5% on 10,000 contracts. This bit of the equation merely informs me how much collateral have I put up to have a 10,000 position. The P&L is dictated by how much your position size moves. The leverage simply says how much collateral you offered to get those contracts in the first place. Leverage equals collateralization, okay?
Now, obviously, there's a bit of nuance there. It's like, well, leverage per position or like how leverage is your account? Forget that for now. We'll deal with it in the video. The basic framework that you need to understand is low leverage typically means you've offered more margin or collateral for that position, and your liquidation is further away from price. And of course, the opposite is true, whereby high leverage typically means you've offered less margin or collateral for that position, which means your liquidation is closer to price. But your main risk management tools will be your position size, and leverage will just be the proximity to liquidation based on how much collateral you've offered for that quote unquote loan, okay?
So, in theory, and we know this isn't really true in practice, leverage is cool for pair trades. So trick, you know, trading, um, pairs you don't own. So, for example, if I think ETH is going to outperform, uh, another layer one, I will buy X amount of ETH and sell an equivalent amount of, uh, that layer one, and I've put on a pair trade. So I'm not exposed to the downside or upside moves in those specific pairs. It's how they perform relative to each other that informs my P&L. So you can set up cool trades like that. Um, leverage also lets you keep less money on exchange. So, you know, if I, if I normally trade with, whatever, average $10,000 position sizes, uh, I can keep, let's say $5,000 or $7,000 on the account, and that still allows me to trade by normal position size by using leverage. So I don't need to keep the full amount I normally trade with on an exchange. And also, as mentioned, kind of in the first point with pair trades, trading coins that you don't own in spots, so sort of just expressing directional views or whatever, pair trades with coins in which I don't hold collateral, right? Just by trading the futures contract itself as opposed to owning spot outrightly.
What I will say is this topic needs its own video. Unless you know exactly what you're doing with leverage trading, and that takes a while to understand, don't pin. If you want somewhere to start, I do have like a comprehensive, um, position size for leveraged trading type of new medium article somewhere. Probably needs an update. But I will also just say, go read the contract specifications on the exchanges where you want to trade, and those will have a lot of information about the products and all the things you need to know to not get destroyed on your first trade.
So some crypto specific considerations. This again could be its own video. It could make it a very long list, etc. But let's go over just three very basic ones, okay? The first is correlations. When Bitcoin and Ethereum nuke, the rest of the market tends to nuke with them, right? That's generally referred to as a strong positive correlation to the downside. So diversification in crypto is still very tricky when it comes to the downside. You know, when the big boys nuke, all the [ __ ] coins tend to go with them. So you often find newer participants or maybe use the equities or whatever else saying, yeah, well, I'm holding some DeFi and holding some exchange coins and holding some layer ones, etc. And that gives them a sense that they're diversified or, you know, their risk is spread out, and you know, if one sector falls, maybe another sector will do better, etc. But generally, in crypto, at the moment, at the time of recording this video, if your big picture read is wrong, especially to the downside, when it comes to the majors, you'll likely eat [ __ ] on all those positions. So while you may think you're diversified by holding, you know, different sectors of altcoins, for example, you're essentially stacking your risk because if you're wrong, they'll all move down in the same direction, right? Specifically the downside. Um, positive correlations are strong. So personally, I tend to prefer fewer high conviction trades, just one and two, rather than trying to bet on direction with like a basket of coins that will on average behave quite similarly anyway, especially to the downside. So, so bear that in mind and be aware that, uh, a lot of the time your risk stacks when it comes to altcoins, given how those correlations play out.
The second one, counterparty risk and exchange downtime. Um, exchanges tend to break during volatility. Still the case. Derivatives, spot, all of it, quite often goes to [ __ ]. Um, so keeping coins on several different exchanges is probably not the worst idea in the world, both to reduce like a rug pull, um, from that specific venue, but also to make sure that if you have to trade and the one of the exchanges, or one of the exchanges we have money is down, you can actually just hedge or do whatever you have to do on another venue without getting completely obliterated. Um, so that's another thing to bear in mind.
And the final one is security. This is probably the most crypto specific one. So many people, you know, spend years in crypto and then type in their MetaMask seed phrase or share their price, share their seed phrase for their wallet or whatever and lose it all, you know, years worth of progress and trading just by some stupid mistake. So security is really important. I've just added some basics here. This is an offset guide, but probably better than nothing. Unique emails and non-SMS two-factor authentication for all sign-ups. Do not reuse passwords. Keep coins on well-secured, credible centralized exchanges. I know it's a bit of a hot take and people say, not your keys, not your coins, but on average, I think it's easier to secure a credible centralized exchange account than it is for most people to secure like a, either a paper wallet or a hard wallet. So that's just my hardware wallet. That's my personal view. Um, or again, as mentioned, or in a hardware wallet without the backup being somewhere easily accessible. Don't click on random links. There's a lot of phishing going on. So, you know, bookmark all the main websites you use, especially exchanges, to avoid phishing. Even if you own a Bored Ape, don't share your seed phrase with anyone that asks. Contrary to popular belief, that's just like not a very helpful, um, thing to do. Maybe helpful for the hacker, but if you want to keep your property, that's just one of the things you don't pass around at every convention you go to or in response to every DM you receive. And I'm sure you've seen this on Twitter and everywhere else, specifically Discord and mods and groups, all this [ __ ] impersonators are everywhere in crypto. So make sure you're talking to whoever you think you're talking to, and if they ask you for money or sorts of personal information, it's probably a scam.
That's it. Conclusion. I'm done. Um, no referral links, courses, ads, upsells, none of that [ __ ]. Just me with an increasingly raspy and broken voice, rambling into my microphone in my mom's basement about risk management. So that's that's cool. If you enjoyed this, if you think it's helpful, if you've been a fan of the technical analysis series and want to see more of the videos get a facelift, make sure to like this video and subscribe. Both of those are free. And if you want to be really nice, leave a comment on this video below. Maybe type it as I'm speaking right now, just waiting for you. Or just tweet at me at crypto cred to tell me how much has changed your life. Don't actually do that. As in, don't tell me it changed your life. It's just a bit of a weird thing to tell a stranger. But if you found it helpful or have any questions, I'd love to hear from you. That's all I've got. Uh, hopefully this wasn't the worst thing you've seen all day or week or whatever. Managed to clock it in an hour 10 minutes. That's all from me. Have a wonderful whatever, and I'll see you for the next video. Merry Christmas as well, or something. Bye.