I recently saw an article on Yahoo Finance / Marketwatch which made me realize that people may not know about portfolio construction or risk management.

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Don’t be like this person. This kind of loss is life altering in a bad way. Making money takes discipline, and losing money just happens to be extremely easy.

RISK MANAGEMENT AND PORTFOLIO CONSTRUCTION – PLANNING

Let’s take a look at where I want to be in terms of a portfolio, and let’s say I am about 25-45 years old, and you are looking to have a little juice in your returns. Readers are probably in some country where one can save from anywhere from USD 1,500 to $10,000 a using a developed country average of 30,000 USD, a 10-12% rate of savings and 6 years of saving, and maybe a couple of ok years in the markets of some kind.. And so, I am going to assume for this journal, I have USD $25,000 saved up. Next, I will I assume, I want to make money in the wild west of trading, cryptocurrencies, where every trade seems to make me more than usual.

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Let me also look at where to set our bar. For argument, just sticking into global stocks through MSCI world, has generated 6.4% to 8.5% depending on reinvestment, so let’s use 7.5% per year as our hurdle. If it looks like I am going to suck so hard in trading that I can’t make this amount, then I should just put it into this kind of ETF and go do something else.


Part-Time Ness of Trading
I am not going to have all day to trade, as I have a job to make ends meet, and I will only have a 2-4 hours a day to dedicate myself to trading and research. That’s not a lot of time, so we will have to figure out a way to make do with this little time.

Portfolio Construction and Constraints – My General Parameters:

1. I would like to save at least 40% of my funds for a rainy day, or $10,000 US Dollars. This I will try to get good/stable returns while keeping this money protected.
2. I am going to also assume, the next year, I can save $2,500 US Dollars, so I know, I can probably afford loss of $2,500 for sure for a year, without feeling like I need to dig out of a multi-year loss. Assuming a 50% drop in an asset price, I can afford to just go “all in” on about $5,000 worth, or I can run 100% loss type trades with $2,500. We will get into more of this later.
3. I may want to find some strategies that I can run in the meantime to help generate returns, but with more measured pace of returns.
4. Discipline: I will NOT deviate from allocation in 2. However, 1 to 3, can expand and contract over time.

Ring Fencing
I always try to make sure that I am in a situation:
Heads = I win.
Tails = Not my problem.
This is where Ring Fencing becomes important and will become more pertinent as we explore Portfolio Construction item 2 above.

For example, having 2 Bitmex Accounts is better than putting all strategies and hedges into one account. One account can be employed for cash and carry or basis trading for (1) and maybe to help with (3) above. The second one, we use to take leveraged bets but leaving smaller capital at risk, we should not mix “good” money with “risk” money whenever possible.

Risk Management:
1. I will consider the risk-return of every position/trade. There will be no trades done without rationale. Those with good returns for lowest risk will be pursued with more size.
2. The highest risk trades will have an allocated loss quota per allotted time period. Again, there will be no risk taken more than what I allot.
3. If there are profits, we will look to resize the bets, but, never where I cannot recover with 1 year of savings.
4. I will not deviate again from this. Discipline is important.
5. I am looking always to play ahead, not behind, while giving us a few shots a year to make it big.
6. I will cut fast and sometimes cut often. I will lean on auto-bust outs like Bitmex and use options at times when risk return makes sense.

Allocation Revisited
I have set out a portfolio and expected returns, but I have pegged a lower threshold to beat. Highest risk will likely be a huge boon or bust. I don’t know. So-I just put in a number. We may be able to even just do arbitrage and highest risk, and not bother in between. Anyways, we need initially set forth a plan and then see how it evolves.

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A Few More things:

Let us get real, we want to make money in a fiat currency – and I am going to use US Dollars. I will not get into the philosophical discussion about how Bitcoin will moon due to macro-economic and global monetary policies and the like. That can be a different topic, and probably one we all might agree anyways. I will only examine how these unique markets in cryptocurrencies can give us an unprecedented advantage of trading even as an “Average Joe”.

I only want to provide a framework to manage a portfolio, as I have done over the years. But I tend to be conservative and look for true and big windows of opportunities in short term trading.

As we move along to specific trade examples, we will go over the risk management component – and this will be very important to the management of the trading portfolio.

Next-up
Next time, we will go over exchanges in details. For example, what advantages does exchanges like Bitfinex, Bitmex, Binance, Huobi, Okex, Deribit, Bitstamp, and Kraken have? Which ones do we use for what? How are we doing to put $25,000 into the crypto system?

Skyhopper