HomeThe Importance of Capital Preservation
The Importance of Capital PreservationLevel: Beginner
SM
Samuel McCulloch
Head of Adara Academy & Trading division. Professional crypto trader with experience in capital markets, options and futures trading.

Warren Buffet, also known as the Oracle of Omaha, has two rules. The first is, never lose money. The second rule is, never forget rule number one.

Now, Mr. Buffet is an investor, not a trader - but his two rules are very applicable to crypto. Too many beginner traders follow the “lose some to win some” philosophy when they should be following Rule #1 and Rule #2. Here’s what we mean.

Let’s say a new, hapless trader - we’ll call her Judy - joins Adara, our crypto exchange. Not one to waste time learning, Bob starts making trades as soon as he makes his first deposit on the platform. After a few losses, Bob thinks:

Well, I can’t be unlucky forever. I’ll just keep making trades and eventually, I’ll make a winning one and recoup everything I just lost.

Unfortunately, Bob isn’t really trading. He’s gambling. This is a huge problem because gambling leads to unpredictable results. It can lead to vast losses and wipe out your whole trading budget even if you’re a very skilled trader.

The bad news is that most new traders are like Bob. The good news is that making consistent profits as a crypto trader doesn’t require gambling. What it does require is strategic thinking, self-control, and careful capital preservation.

This article will focus on the latter. We’ll start by explaining why winning isn’t the most important part of trading.

Why not losing is more important than winning

Would you rather win a million dollars and immediately lose them, or win ten thousand and keep them?

When you put it this way, the answer is obvious. Winning a little bit of money and keeping it is better than winning big and losing everything. Unfortunately, the average trader loses sight of this when working.

Instead, we traders tend to look for the big win; the home run; the jackpot. As a result, we often take on more risk than we should. This leads to one of three scenarios:

  1. We win big, but only after taking so many losses that we end up breaking even or in the red.
  2. We win big, but then consistently lose money (or just about break even).
  3. We don’t win big because our losses have wiped out our trading budget.

Believe it or not, chasing big wins is literally the biggest and most common reason for crypto traders not making money. Focusing on potential winnings leads to greed, passion, and irrational decisions. It leads to gambling, which is something you want to avoid at all costs.

Most importantly, chasing big wins makes traders take on too much risk and lose capital. To explain why this is worse than not making money, read on below.

The true cost of losing money

A drawdown is the process of losing some of your capital. To explain why they can be a big problem, consider the following example.

Let’s say you have $1,000 dollars. If you lose $200, you’ve lost 20% of your capital; bad, but not horrible. But how much money do you have to make to get back to $1,000?

In absolute terms, the figure is the same: $200. But as far as percentages go, you now need to make 25% of the $800 you have left to get back to where you started.

Do you see how this works? After a 20% drawdown, you need 25% to get even. In other words, you’ve got to make more than you lost. This is the problem with drawdowns, and the reason that not losing is more important than winning.

In the end, it doesn’t matter how much you’ve won or stand to win. If you draw down to a certain point, coming back is virtually impossible. For example, an 80% loss of capital requires a 400% profit for you to break even. In theory, this is something you can recover from - but only if you’re an exceedingly savvy trader.

The lesson is that it doesn’t matter how much money you make as a trader. What matters is how much money you make while keeping losses to a minimum. Your winnings don’t matter if you lose everything you make (or more).

Ways to keep losses to a minimum

Now that you understand the importance of capital preservation, how can you actually avoid losing money?

The first step is having a plan and sticking to it. To quote another old adage, you want to plan the trade and trade the plan. Think everything you’re going to do before it happens. This includes entry and exit points, which analytical tools you’re going to use, which tokens you will and won’t trade, etc.

You never want to be caught unawares in the middle of a trading session. If you do find that something unexpected happens, make note of the event and prepare for ways to best deal with it in the future. Do this for long enough, and you’ll know exactly what you need to do when trading, every time.

Note: if you don’t have a plan, visit Adara Academy and follow our video series to make one right now.

Second, you want to put yourself in a position to execute your plan flawlessly every time. Give yourself everything you need to feel calm and focused. Many good traders make mistakes because of their environment, and you don’t want that to be you.

This means having a backup Internet connection in case you go offline, finding a quiet place where nothing’s going to disturb you, making sure you’re not trading with more money than you can afford, etc.

At this point, you have the foundation of a solid capital preservation strategy. What you can do now is learn from other, more experienced traders and teachers - and incorporate what they know into the previous two tips.

The reasoning is that, at the end of the day, capital preservation is about two things: having a strategy that includes effective risk management and executing consistently. On a basic level, that’s all there is to it. The trick is gathering enough real-life experience to make your fundamental strategy effective and profitable.

One way you can get this experience is by winning and losing your own trades. Another is to check out our free knowledge library - Adara Academy - where some of the web’s top crypto traders and instructors share their risk management tips.

Thank you for reading - and if you have any tips, questions, or comments, please let us know

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