Crypto Investing
3 Mar 2021

Crypto Risk Management Strategies in 2021 for High-Profit: Enter and Exit Assets with Precision

Farheen Shaikh

Key Takeaways

  • Crypto risk management as a way to minimize capital erosion
  • Qualitative and quantitative market risks, including security risks, liquidity hazards, and more
  • How is crypto investment corpus related to trading risks?
  • Managing trading risks reactively using Stop-Loss
  • Proactive position sizing 
  • The one-Percent rule for active traders
  • Using risk-to-reward ratio for identifying trades
  • Short squeeze to get back the eroded amount, but with a hint of risk

As much as we recommend the DYOR (Do Your Own Research) approach for crypto assets, active trading isn’t always a game of intellect. Instead, if you are more into swings and positional trading rather than ‘HODL’ing (HODL means sticking long with a crypto asset), learning a bit about granular risk management seems like a better way, moving ahead.

Despite having a reliable score of indicators around, trading in an asset class with profits, especially the crypto space, is anything but guaranteed. Therefore, if you strive to be a successful trader, the first approach should be to minimize capital erosion (Loss of investment). Once capital safety is assured, you can lock in gains as and when deemed fit.

Easier said than done! Trading in cryptocurrencies is a whole new ball game compared to other asset classes. Higher risks, overshooting FUD (Fear, Uncertainty, and Doubt) quotient, and market volatility that even outpaces Elon Musk’s tweeting moods; the crypto-space is appropriately queer and requires precisely mapped Crypto risk management strategies that work, regardless of the market movements.

In the subsequent sections, we shall address some of the best risk management strategies that have found massive acceptance levels in 2021, courtesy of their validated benefits.

Crypto Risk Management Strategies in 2021: Eliminate Trading Risks for Good

Guessing that you are familiar with the famous adage, i.e., ‘Money saved is Money earned,’ it makes sense to have a risk management strategy to protect the capital at first. But then, who wouldn’t want to take a menial amount of risk in a space as profitable as crypto. 

Despite several indicative, historical, and statistical risk management strategies, nothing actually works unless you are aware of how the market risks in general. Trust us when we say that volatility should be the least of your concerns in a market space as seasoned and vast as crypto.

Regardless of a wide array of hazards, including security, exchange, custodial, and legal risks, we shall keep our discussion restricted to the more financial ones, including liquidity, capital erosion, market, and leverage-specific risks. 

Important: It is well known that none of the risk management strategies would work if you end up risking more than what you can afford to let go of. Coming to the crypto-space where assets move frantically on sentimental triggers, the first step towards comprehensive risk management is to invest prudently and not more than 10 percent of your corpus. At least, for now!

Best crypto risk management strategies

Effective Risk Management Techniques

A few days back, we heard someone saying, ‘Why do I even need a risk management strategy when I can easily become a Bag Holder?’ Point taken, Bag Holders end up going long with their trades, thereby minimizing the risk exposure. And, we all know that we lose money only when we sell.

As much as this sounds perfectly doable, there is a catch. Imagine yourself investing Rs.1000 in the Crypto space with eyes on Rs.2250 as the medium-term target but suddenly, the prices nose-dive for some reason. You start taking hits with the hope that prices will soon move up and, therefore, let go of a risk management plan.

By the end of next month, you find yourself sitting on Rs. 250 with nothing to do but wait. Also, while you have lost 75 percent of your corpus, getting it back to Rs. 1000 would mean making profits worth 300 percent. 

This means, if you go long with your losses, you always end up lagging behind the market, with no clear view as to when the prices will bounce back. This is precisely why a risk management strategy is necessary.

But, which risk management strategy to follow? Well, here are the best ones to consider learning:

  • Stop Loss
  • Position Sizing
  • Risk-Reward Ratio
  • Short Squeeze (Risky)

So, let us dig right into how each strategy works, depending on the context of your trading habits:

Stop Loss

Arguably the simplest and most prevalent strategy to minimize trading risk, Stop Loss is simply an executable trader order, which automatically closes an open position if the asset class value falls below a particular threshold. 

While some might consider this as a way to minimize loss, stop loss is often used to maximize profit booking in a volatile market. Plus, this is one of the few risk management techniques that rely heavily on the usage of indicators like Moving Averages, candlestick patterns, and more to help you determine the right exit points. 

Note: The ‘Stop Loss-Take Profit’ strategy might change a bit depending on the type of trade you plan on executing. Different trades require you to view indicators across different time frames, which also determine the stop-loss price, trailing stop loss point, and other factors. Therefore, it is advisable to view the cryptocurrency across multiple time frames, to make the right calls. 

Position Sizing

Let us put the concept of stop loss to better use, shall we!

Well, position sizing is one of the best day trading risk management strategies in plain sight, as it has a pretty simple goal, i.e., to help you diversify assets to minimize loss. It would also be safe to say that profit sizing doesn’t actually worry about how much profit you might make.

Instead, it lets you identify the optimal trade value that you need to use, depending on the stop loss and, certainly, your risk appetite.

Imagine you have Rs. 10,000 in your trading account. Also, you are willing to risk 2 percent of your investment, to achieve an upward target of almost 10 percent. Then again, the upward percentage doesn’t matter here.

Now consider that the given script is trading at Rs.900 and you have the stop loss set at Rs.810, making the distance to stop loss Rs. 90. Therefore, as per the given formula, i.e. Investment = (Account size x Risk appetite) / Stop-Loss distance, the investment value comes out to be, 

{(10000 x 0.02) / (900 -810)} x 900 = 2000

Therefore, you should only allocate 20 percent of your account size for this trade to get the most out of your decisions.

Important: While we did consider 2 percent as the risk appetite per trade, in a market as volatile as the Crypto-space, the One-percent rule is advised and commonly used. This means you should not let your investment value depreciate by more than 1 percent, for any active trade. 

Risk-Reward Ratio

Another dependable risk management strategy has to be the one concerning the proper identification of the risk-to-reward ratio. We stand to believe that the risk-to-reward ratio paints the truest trading picture, as it considers your expected profits alongside the trading losses that you might incur. 

The formula for calculating the Risk-to-Reward ratio is (Target Price – Entry Price) / (Entry Price – Stop Loss). A risk-to-reward ratio should always be higher than 1:1 for the trade to be considered profitable. Anything less would mean that it isn’t prudent enough to allocate a certain portion of your capital on an asset with a paltry target compared to the distance to the stop loss. 

Short Squeeze

Each of the three risk management strategies mentioned above is restrictive and proactive in nature. However, a short squeeze is one eccentric way to minimize risks, albeit in the longer run. Plus, this approach is best suited for short-sellers, who had to opt-out as the prices suddenly started moving up, as opposed to their inferences.

Short sellers, while squaring off their positions, need to buy back the asset. Buying back or squaring odd in larger quantities can push the price upwards, making it cross the key resistance levels.

Once the asset moves to the demand zone upon crossing the resistance, the risk to reward ratio increases, as the asset has lesser chances of going down. At this point, investors can quickly get back the lost money upon investing with a proper strategy in place.

Regardless of the mathematical and statistical analysis, every risk management strategy hinges on three important trading facets, i.e., Asset Allocation, Diversification, and Rebalance. Plus, trading is never a one-dimensional ballgame, with the odds shifting every second, making cryptocurrency risk management all the more important for short-term, active traders.

Considering the pertinent nature of risk management, we hope that this brief outline could be of assistance.

FAQs

Q1. How do you manage risk in trading?

A1. The simplest way to manage risk is to put a stop-loss. Not keeping a stop loss, especially in a volatile market, amplifies your risk exposure and can jeopardize your capital.

Q2. What is the 1% rule in trading?

A2. This rule eliminates the possibility of letting your investment depreciate by more than 1% as a part of a comprehensive risk management plan.

Q3. What are the three risk management strategies?

A3. Stop-loss trading, position-sizing, and taking calls based on the risk-to-reward ratio are the most dependable risk management strategies in play.

Aware of how risk management works in regard to crypto trading! Try the strategies out first-hand by downloading the app and getting started on the crypto journey.

Disclaimer : Crypto products and NFTs are unregulated and can be highly risky. There may be no regulatory recourse for any loss from such transactions. The information provided in this post is not to be considered as investment/financial advice from CoinSwitch. Any action taken upon the information shall be at user's own risk.

writer

Farheen Shaikh

Content Writer

Table of content