Welcome back! In our previous lessons, we looked at individual trades—how to size them and where to place the "lifeline" stop-loss. But now, we need to zoom out.
Even if you follow the 1% Rule perfectly, you can still face a "death by a thousand cuts." If you lose ten trades in a row, you aren't just down 10%; you are facing a psychological and mathematical hurdle called Drawdown.
In this lesson, we’re going to define Maximum Drawdown (MDD), set portfolio-wide safety nets, and learn how to spot Concentration Risk before it sinks your entire ship.
1. Defining Maximum Drawdown (MDD)
In the professional world of hedge funds and asset management, Maximum Drawdown is the metric that investors care about most. It’s not about how much you made; it’s about how much you "bled" to get there.
Definition: Maximum Drawdown is the maximum observed loss from a portfolio's peak to its subsequent trough, before a new peak is attained.
MDD =Trough Value - Peak Value
_____________________________________
Peak Value
The "Recovery Math" Trap
Why does MDD matter? Because losses are not linear; they are exponential. According to Investopedia and standard financial theory, the more you lose, the harder you have to work just to get back to breakeven.
- 10% Loss: Requires an 11.1% gain to recover. (Manageable)
- 25% Loss: Requires a 33.3% gain to recover. (Difficult)
- 50% Loss: Requires a 100% gain to recover. (Extremely difficult)
The Expert Perspective: Protecting your principal isn't just about being cautious; it’s about avoiding the "math of ruin." Your primary job as a trader is to keep your drawdown small enough that a recovery is statistically likely.
2. Setting Portfolio-Wide Risk Limits
To prevent a massive drawdown, you need a "Circuit Breaker." Just like the New York Stock Exchange halts trading when the market drops too fast, you must have rules that halt your own trading.
The Daily/Weekly "Uncle" Point
Professional traders often use a Daily Stop-Limit.
- Example: If your total portfolio value drops by 3% in a single day, you must stop trading for 24 hours.
This isn't because you've run out of money; it's because your "mental capital" is likely depleted. Trading during a drawdown often leads to Revenge Trading, where you try to "win back" losses by taking higher risks—the fastest way to turn a 3% drawdown into a 20% disaster.
Setting an Absolute Trough
You should define an absolute "Stop-Loss" for your entire portfolio. For many, this is 20%. If your account drops 20% from its all-time high, you move to cash, stop all bots, and re-evaluate your entire strategy.
3. Identifying Concentration Risk
This is the silent killer of crypto portfolios. You might think you are diversified because you own ten different "altcoins," but if they all drop when Bitcoin drops, you aren't diversified—you are concentrated.
The Correlation Trap
In crypto, most assets have a high Correlation Coefficient with Bitcoin.
- Real-World Example: During the market deleveraging events of 2022 (cited by Glassnode and Chainalysis), almost all top 100 assets saw a 0.8+ correlation.
- The Risk: If you have five "long" positions open on different AI-themed coins, and the AI sector takes a hit, all five of your 1% stop-losses will hit at the exact same time. Your 1% risk trade just became a 5% portfolio hit.
How to Spot It on Walbi
To manage concentration risk, look at your Asset Exposure:
- Sector Risk: Are all your agents trading the same sector?
- Directional Risk: Are all your agents "Long"? If the market flashes red, you have zero protection.
- Platform Risk: Are all your funds tied to one specific strategy?
Key Actionable Takeaways
- Monitor the Peak: Always track your portfolio's "High Water Mark." Your drawdown is measured from that peak, not your starting balance.
- Respect the Recovery Math: Never let your drawdown exceed 15-20%. Once you cross that line, the gain required to break even starts to become unrealistic.
- Diversify "Logic," Not just "Assets": Don't just buy different coins. Use different strategies (e.g., one Trend Following agent and one Mean Reversion agent) so they don't all lose at once.
- Install Circuit Breakers: Define a daily loss limit (e.g., 2% of total capital). If you hit it, walk away. The market will be there tomorrow; your capital might not be if you stay.
In the next lesson, we’ll tackle the most misunderstood tool in the trader’s belt: Leverage—and how it can lead to total ruin if you don't respect it.
