Bitcoin – Consolidation Continues – Managing Risk in Different Environments

Overview:

Bitcoin continues to consolidate and we are looking for the market to range for a couple weeks to a month or so.  Sounds like forever, but a move this dramatic this early into a bull market cycle is likely to cool down before finding its legs for the next swing higher.

There have been a lot of request on position sizing and risk management.  How we adopt to the market environment and capital allocation for an individual trade.  This gives an overall in how we position size based on the environment, or at least a brief overview.

BTCUSD:

There are two weekly candles stick patterns that provide pause in the market.  Weekly pin-bars, after extreme moves, often signal a reversal.  In this case buying momentum continued from the previous two weeks, but sellers stepped in pushing the price lower near the end.

The current spinning top is a sign of market indecisiveness.  On smaller time frames this appears as a ranging market.

We had a similar consolidation back in April.  Several tight consolidation candles in a row.  Unlike the consolidation in April, which followed a bullish candle, implying a continuation, this is following a bearish one implying there is still risk to the downside.  This does not imply we did not buy the dip, we did, but we understand the risks associated here.

Technically we can still swing as low as 3250 and still be in a bullish cycle.  It is highly unlikely we see 6000, but we never discount anything.  A deep pullback based on current structure and price action would be somewhere in the mid 8k area.  A swing below 9500 is sure to bring the bears out in full force, flushing out late longs and range traders.  We would view this as a buying opportunity for the broader move higher.

It is most probable that a pullback in the mid 9k’s is as deep as it gets.  Those selling at 12-14k are likely looking to buy back in, and this would be a 30% pullback from the top.  Of course Bitcoin has a history of “V” shaped corrections and it can catch its breath quickly, break range, and continue higher.

Currently the 9651 low is enough for us to consider a bottom is in place and a completion of wave 2.  We simply have no way of knowing until the market reveals its hand by taking out 16,000.  This would likely confirm wave 2 has completed and wave 3 is now in play.  Until then we consider it a ranging market.

BTCUSD Daily:

We are still early into the consolidation cycle and there are various ways this can play out.  For now we are assuming this will be a ranging market between 10 and 14k.

As mentioned above the low could be in already, and we are looking at the beginning of a broader move.  If this is the case we will adjust and add to our current position using our remaining 10% cash on hand.   If the market pulls back we still have capital to deploy.

Trading consolidation channels in hindsight look easy.  Buy the low of the range, sell the high.   Simple enough but consolidations can unfold in many ways and trading them does not come without risks. Lets look at two out of numerous scenarios possible. 

BTCUSD 12 hour

The risk of trading consolidation ranges is it breaks into a trend, or appears to break range and fakes out.  For example, BTC pushes into the 13,000 area and trader sell positions from lower levels.  The market pulls back to the lower end of the range.  Buyers step back in looking for a swing higher but Bitcoin breaks range, trends lower, trapping longs.

These longs cut their losses adding to selling momentum, and we get a deeper pullback then expected into 8k area or even lower.

The other risk is a long fake-out.  Longs sell the top of the range, it starts pulling back and then reverses taking out the upper level of the range.  Those that sold, scramble to get back in, it fakes to the upside and then pulls back quickly to the lower end of the range.

This is just two of the numerous types of consolidation patterns that make them difficult and tricky to trade.  Again after the fact it looks easy, but most are easily spooked out of their positions during range bound markets.  This is why position sizing is critical.

Trading Environment:

Ranging markets are an environment where fake-outs are quite common.  Sentiment quickly changes resulting in whip saw moves on smaller time frames.  This is a difficult environment to navigate and takes a disciplined trader to stick to their guns.

One way to keep from jumping in and out is reducing risk.  Reducing risk allows you to focus on the time frame applicable to the chart and not worry about a big loss.  If your trade was based on a daily, and you are focusing on a 4 or 2 hour chart and watching every move, you probably have to large a position.

So how do you adjust?

First reduce your position size.  In areas during or after vertical moves, or consolidating markets, we adjust our risk.  We call these “aggressive” areas for trading as they have a higher percentage of failing to hit their targets.  A less aggressive trade environment would be IF Bitcoin pulled back to 8000 and provided a bullish reversal.

Why is a pullback to 8k less risky than a trade here?

In this situation the downside risk has been reduced and late longs were likely flushed out.  Both the broad and mid term trends are bullish, and a bullish reversal out of a shorter term trend has a high probability of success.  This is where we would increase our position size as it is a more conservative area to trade from.  So how do you calculate position sizing.  Its simple, all in all out right?  Not exactly.

Calculate your risk:

This is a very simple calculation if you are using proper signals.  If you are receiving trades from anyone or doing them yourself, it starts with a clear defined entry, stop loss, and target(s). Without all the above it is impossible to gauge risk, reward and adjust position size.  Lets look at a swing trade we issued a few weeks ago labeled “aggressive”.

BTCUSD

BTCUSD (Aggressive)
Buy Stop:  11,175 (Entry level when the level is hit not before)
Stop Loss:  10,350 (There to prevent a steep loss)
T1: 12,150
T2: 12,850
R:R 1.61

The trade above was issued on 06/23/19 and we considered it to be aggressive based on position, type, and a clear 3 wave pattern already printed.  Notice the signal is crystal clear, there is no wiggle room or vagueness to the trade.  So you take your 10k trading capital and go all in right? Wrong!

First you need to wait for the trigger and then enter.  We rarely place limit orders as you are buying into selling pressure not buying momentum.  The Buy Stop helps to filter out the noise in markets by entering on a continuation of a trend, not a hopeful reversal.

In order to calculate the capital allocated for a swing trade you need two numbers, the Entry and Stop. Many signal providers keep these vague for a reason.  They can claim they never got in, or victory with a loose stop.

If clear precise entry and exit levels are not provided, it is impossible to determine the risk size and our calculate the position size.  If target levels and type of trade is not provided, one can not determine the capital risk for the trade. This is why it is important to have very clear trade signals, not vague ones.

Percentage Risk:

Your position size is based on the percentage risk of your trade capital.  Since this was labeled an “aggressive” trade, our risk is adjusted from 2-3% (normal trade) to 0.5-1% (aggressive trade).  This is predetermined based on the type of trader you are and your account size.

More conservative traders, with larger accounts, generally do not risk more than  1-2% of their accounts and reduce this in half for more risk-averse trades, or simply step aside.   Those with a more aggressive nature will risk up to 3% of their capital for higher probability trades, and reduce this to 1-1.5% for higher risk (aggressive) trades.

Obviously higher probability trades are less common than “aggressive” trades.  High probability, high return trades are rare, but when they show up, if you blew out your account trading crappy signals, poor trading environments, or because you didn’t manage your risk, you will not reap the rewards.  Many found this out over trading the market last year and are now trading out of a hole.

We also have guidelines for each type of trade.  Note here the R:R was 1.61.  Based on 1% risk of our capital, our return overall is 1.61%.  For aggressive trades we need a higher R:R multiple and we lower our risk capital. If we were risking 3% of our capital, our return would be 4.8% (3 x 1.6).

Risking 1% to make 1.6% implies we only need to hit a 40% success rate to make money.  Exiting trades early if there is a sign of failing, and or letting winners run will increase these returns over time.  For the sake of accountability, it hits our targets that is it.  

Calculate Position Size:

The only two numbers required to determine position size is the entry and the stop.   The following example is for a typical 10k trading account:

Capital Risk = %risk multiplied by account size (we used 1% risk for this trade)

  • $10,000 x 0.01 = $100.   ($100 is the capital we are willing to risk)

Unit Size = Risk Capital / (Entry – Stop Loss)

  • $100/($11,175 – $10,350) =  0.12 units.  (Our position size for the trade would be 0.12 BTC)

Capital Allocation =  Units x Entry

  • 0.12 x $11,175 = $1341  (This is the capital deployed for the trade based on unit size)

Our trade size is $1341 period.  If our trade is stopped out we only lose $100 or 1% of our overall capital.  If both targets are hit, the profit is $161 or 1.61% of our overall capital.

So all in all out implies that the “Capital Allocated for the Trade” is all in all out, not our total capital allocated for swing trading.

Percentage not Price:

Some may think, that is silly, why not trade a lower priced equity?  Say Litecoin or even EOS you get more coins and make more money!

In reality it does not matter.  You are still only risking 1% of your capital to make 1.6% profit.  Whether you are buying 0.12 Bitcoin or 100 EOS the risk and profit are the same.  You may be trading more units or coins, but in the end you are still risking $100 to make $160.

One reason we opt towards higher price equities and not penny stocks or coins is smaller priced equities see more noise.  This results in getting stopped out more often.  The other reason is they are less liquid then Bitcoin which creates a greater potential of slippage.

Not that we do not take the occasional trade in lower priced equities, but our guidelines require the R:R to be higher.  We will never take a trade with XLM or other penny coins, which are more conducive to position trade strategies.  These don’t have stops and your risk is calculated differently.

Diversity:

Market sectors are generally correlated.  Sure there is the anomaly where one coins bucks the trend, but as a general rule a rising tide raises all ships.  Generally if there is a trade signal with Bitcoin others will have a similar setup.  Some will lag, which is a different thing, but taking more than 1-2 trades in a correlating market is risky.  Taking 5-10 is poor money management.  Taking 20 is all out gambling.

Risking 1% on 10 equities in a correlating sector is no different than risking 10% on one.  In fact it is counter productive.  Professionals trade the sector leader in general.  Now this is often subjective to the individual which is the leader, but it does not take a rocket scientist to pick the best looking chart.

If the market turns, it is likely all your trades will be stopped out for a 10% loss.  If the market rallies, some may hit their targets, and others will not.  This waters down your potential returns.  You are risking more for watered down returns.  Hoping they all hit their targets is a hopeless strategy.

In addition if the market turns, it is difficult enough to exit one position let alone five.  This can lead to slippage and further deteriorate your trading capital.  Especially if your position is of any size.  Try dumping 30 Dash into a selloff.  Worse yet your stop triggers, and there are no buyers, so you see 20%+ slippage beyond your stop.

Summary:

Ranging markets can provide opportunity if you are aware of potential risks.   During these periods it is important to understand your environment and adjust your position size accordingly.  A stop is only there to provide a maximum loss, the key is knowing when to exit early.

Set realistic goals like 15-25% on average a year for swing trading.  This is about 2 trades a month in a specific sector.  Be picky and do the math before entering a trade.  We get quite often “why didn’t you take that trade?”  Sometimes the R:R does not meet our criteria for the area, position or type of trade.

Other times the targets needed based on the stop level, do not work out to what is relevant based on market conditions.  Sure we could place a target at 16k and the R:R works out, but that is hopeful targeting not proper risk management.  It will bite you in the pocket eventually.

These types of trades where R:R does not work as a swing trade are more conducive to day or scalp trading.  Nothing like sitting at a computer watching every tick on a 3 minute chart all day.  Most people have jobs and can not monitor a 30 minute chart let alone a 1-3 minute one.

Many use swing trading to compliment position and long term investing, though a trader must be disciplined enough to separate accounts.  Others are attempting to build up their cash equity.  Those trying to get rich quick are often the first to the poor house.

This is why it is important to have predetermined goals, define your strategy(ies) and create rules and boundaries to implement.  Just bouncing from strategy to strategy or taking a daytrade and making it a position trade defeats risk management and will diminish your long term gains.

If you are registered as a free member make sure you check out our members page for updates.  Also tomorrow we have a guest in the studio.  A long time friend and fellow trader Phil Skirball.   We will talk about Bitcoin, trading strategies including TVIX, SVXY and UVXY.

 

Image by tom bark from Pixabay

 

 

 

8 Responses
  1. mvleeshouwers

    Thanks so much for this explanation regarding position size.
    I have closed out the trade you issued on 07/02 with a minor gain, as the trade was issued late at night for me (due to time zone difference) the market had risen above the buy stop level. I was in doubt and stepped in anyhow. Luckily it turned out ok this time (I sold with a minor gain). Providing this risk analysis showed me that I was risking more than I stood to gain. Not the trade I want to be in.

    Cheers mvleeshouwers

    1. Andrew Gonci

      Thank you for sharing. Yes too big a position can often lead to getting cold feet early. With a 20k account buying 2 bitcoin with a 1000 pt stop can have you nervous if it hesitates or jerks around. Reducing your trade size to 2500 risking 1% puts you in a much better position to let the trade play out. Not too much sweating if your loss is $200 on a 20k account. $2000 well that hurts.

      Big positions cause big problems, if you don’t get caught now you will get caught eventually.!!

  2. Istvan Szoboszlai

    Thanks for the article. It is really useful.
    One detail I would like to add for the math: I do not exactly know where you trade, bot on a normal crypto exchange (eg. Coinbase, Binance, Kraken), if you post a stop order it either market sells or limit sells. If it limit sells, then there is a chance, that your order does not even get filled. If it market sells, then – in case of a bigger selloff -, your average exit price might be significantly lower than what you specified as stop loss price. And you also pay fees that can add up to your losses.
    What I would like to point out is that the real R:R is slightly worse than the one provided by the math above.

    1. Andrew Gonci

      Thank you for the comment, you made a great point.

      You are absolutely correct. A market stop order only guarantees it sells if the stop is hit. It does not guarantee price. I know Coinbase has a 10% slippage net in place, but still this can sometimes double a loss.

      This is why we reduce our position size and trade the most liquid assets in the space. Trying to trade low liquidity coins on some exchanges can result in a huge loss even with a stop. Especially with Bitcoin pairs. The wicks are just crazy, a lot of noise.

      Like the example above owning 2 Bitcoin with a 20k account and getting 10% slippage is a 20% loss. However using proper sizing and risking only 1%, 10% slippage on a market order is only 2% or $400. It happens rarely but you want to minimize risk when it does, and in these areas risk is elevated.

      This is why we attempt to exit before the stop if the trade is not working out. The stop is really a last resort.

  3. onurerbas

    A very nice article Andrew, thanks.

    You guys are always open hearted and think of peoples good by teaching them the very core principles of a healthy trade, even in the free articles. I also believe that your premium members are very lucky -and I’m willing to join in the upcoming future.

    Most of the so called analysts on the market just feed people with garbage, only trying to inject new money to the market so that they can make more money.

    Considering the impulse waves 1 (@12.000) and 3 (@12.750) on 4th and 9th of July, it seems like a parallel trend channel is forming in BTCUSD pair and will likely to cause a 5th wave at 14th of July. Will see if it will throw-over with enough volume.

    Kind regards,

    Onur

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