Derivatives Risk Management
Why Risk Management is Most Important
In derivatives trading, risk management comes before profit strategy. No matter how high your win rate, a single large loss can wipe out your entire account.
The biggest difference between professional and amateur traders is not analytical ability but risk management ability. Professionals survive even when wrong; amateurs exit after one big mistake.
"If you don't manage risk, risk will manage you."
Position Sizing
The 1% Rule
Never lose more than 1-2% of total capital on a single trade.
This is the most fundamental principle of derivatives risk management.
Example: Account balance $50,000
- 1% Rule: Maximum loss per trade = $500
- 2% Rule: Maximum loss per trade = $1,000
Position Size Calculation
Position Size = Maximum Loss Amount / (Entry Price - Stop-Loss Price)
Account $50,000, 1% rule applied, BTC long entry at $100,000, stop-loss at $97,000 (-3%):
- Maximum loss amount = $50,000 x 1% = $500
- Price difference = $100,000 - $97,000 = $3,000
- Position size = $500 / $3,000 = 0.167 BTC ($16,700)
- Effective leverage = $16,700 / $50,000 = approximately 0.33x
According to this calculation, high leverage is unnecessary. Position size determines risk, not leverage multiplier.
Position Sizing Table
$50,000 account, 1% rule ($500 maximum loss):
| Stop Distance | Position Size | Effective Leverage |
|---|---|---|
| -1% | $50,000 | 1x |
| -2% | $25,000 | 0.5x |
| -3% | $16,700 | 0.33x |
| -5% | $10,000 | 0.2x |
| -10% | $5,000 | 0.1x |
The wider the stop distance, the smaller the position must be. This is the core of risk-based position sizing.
Stop Loss
The Necessity of Stop-Loss
Derivatives trading without stop-loss is like high-speed driving without a seatbelt. When price moves against you, hoping "it will come back soon" is the most expensive emotion.
Stop-Loss Setting Methods
Technical Analysis Based:
- Set slightly below/above support/resistance
- Set below moving averages
- Set below/above recent swing lows/highs
Percentage Based:
- Set at a fixed percentage from entry (e.g., -3%, -5%)
- Adjust based on volatility (wider for volatile coins)
ATR (Average True Range) Based:
- Set stop distance at 1.5-2x ATR
- Automatically adapts to market volatility
Stop-Loss Principles
- Decide stop-loss location before entry. Deciding after entry leads to emotional decisions
- Never widen a stop-loss once set. "Let me hold just a bit longer" is most dangerous
- When stop-loss triggers, don't immediately re-enter in the same direction. Analyze again before deciding
- If stops trigger frequently, your entry timing is wrong. Modify entry criteria, not stop placement
Risk-Reward Ratio (R:R)
Concept
Risk-reward ratio is the ratio of expected profit to accepted loss.
R:R = Target Profit / Accepted Loss
Example: Entry $100,000, stop-loss $97,000 (-$3,000), take-profit $109,000 (+$9,000)
- R:R = $9,000 / $3,000 = 3:1
Minimum Standards
| R:R Ratio | Evaluation | Required Win Rate (Breakeven) |
|---|---|---|
| 1:1 | Insufficient | Above 50% |
| 2:1 | Minimum standard | Above 33% |
| 3:1 | Good | Above 25% |
| 5:1 | Excellent | Above 17% |
With 3:1 R:R, winning just 1 out of 4 trades breaks even. Trading at this ratio, you profit long-term even with 30-40% win rate.
Rather than pursuing high win rates, only trading opportunities with high R:R ratios is the professional approach.
Capital Management
Account Separation
Separate total investment capital as follows:
| Category | Ratio | Purpose |
|---|---|---|
| Spot Holdings | 60-80% | Long-term investment. Separate from derivatives |
| Derivatives Account | 10-30% | Trading capital |
| Reserve Funds | 10% | Emergency opportunities or additional margin |
Don't put all assets in derivatives accounts. In the worst case, even if you lose the entire derivatives account, 70-80% of assets are preserved.
Maximum Drawdown Limits
Stop trading when account drops below a certain percentage from peak.
- -10%: Reduce trading frequency and position size
- -20%: Stop trading. Review strategy
- -30%: Complete stop. Take a break, then restart with small amounts
The key is reducing position size during losing streaks. Increasing size to recover losses almost always leads to larger losses.
Leverage Management
The Reality of Leverage
| Leverage | Move to Liquidation | vs BTC Daily Volatility | Actual Risk |
|---|---|---|---|
| 2x | ~50% | Very safe | Low |
| 5x | ~20% | Safe | Low-Medium |
| 10x | ~10% | Normal | Medium |
| 20x | ~5% | Risky | High |
| 50x | ~2% | Very risky | Very High |
| 100x | ~1% | Routine liquidation | Extreme |
BTC's daily volatility averages 2-5%, reaching 10-20% on extreme days. At 20x or higher leverage, normal volatility alone can trigger liquidation.
Appropriate Leverage Guide
- Beginners: 1-3x. Use isolated margin
- Experienced: 3-10x. Combine with position sizing and stops
- Professionals: Varies by situation, but usually under 10x
Capturing big moves with low leverage is more profitable long-term than earning small amounts with high leverage.
Psychological Management
Emotional Traps in Derivatives Trading
FOMO (Fear Of Missing Out): Entering late after seeing price surge. Usually leads to buying the top. If you missed the opportunity, wait for the next one.
Revenge Trading: Immediately entering opposite direction or larger position after a loss. Emotional decision-making almost always fails.
Overconfidence: Dramatically increasing position size or skipping stop-losses after consecutive wins. Big losses usually occur right after winning streaks.
Loss Aversion: Quickly locking in small profits while letting large losses run. The "short profits, long losses" pattern. You need to do exactly the opposite.
Coping Methods
- Keep a trading journal: Record the reason, result, and emotional state of every trade
- Rule-based trading: Pre-determine entry/stop/profit criteria and execute mechanically
- Daily trade limit: Prevent overtrading
- Rest after losses: Take a day off after 2-3 consecutive losses
Event Risk Management
High Volatility Events
| Event | Expected Volatility | Response |
|---|---|---|
| FOMC Rate Decision | High | Reduce leverage or close positions |
| CPI/PPI Release | High | Reduce position size |
| Bitcoin Halving | Medium | May already be priced in |
| Regulatory News | Unpredictable | Always be prepared. Stop-loss mandatory |
| Exchange Incidents | Unpredictable | Diversify assets. Avoid excessive concentration on one exchange |
Weekend/Holiday Risk
Cryptocurrency trades 24/7, but liquidity decreases on weekends. Lower liquidity can lead to larger price swings, making high-leverage positions over weekends risky.
Exchange Risk
Asset Diversification
Don't concentrate all funds on one exchange. The FTX collapse showed that exchanges can fail regardless of size.
- Derivatives accounts: Spread across 2-3 exchanges
- Keep only minimum necessary funds on exchanges
- Store the rest in personal wallets (hardware wallets)
API Key Management
For automated trading, disable withdrawal permissions on API keys. Grant only trading permissions to prevent fund theft in case of hacking.
Practical Checklist
Items to verify before every trade:
- Is the entry reason clear? (Analysis-based, not emotional)
- Have you set a stop-loss?
- Is the risk-reward ratio at least 2:1?
- Does position size follow the 1-2% rule?
- Is a high-volatility event imminent?
- Are you within drawdown limits?
- Is your emotional state stable?
If any answer is "no," don't trade.
Summary
In derivatives trading, survival comes before profit. Limit position size with the 1-2% rule, set stop-losses on every trade, and only trade opportunities with 2:1 or better R:R ratios. Lower leverage is safer, and reducing positions after losses is the correct response. Psychological management and rule-based trading have greater impact on long-term profitability than analytical ability.
Next article: Hedging Strategies - Using Derivatives for Spot Holders