Crypto trading is fast emerging as an alternative to trading in equities. While the popularity of crypto trading is on the rise, trading is said to be one of the toughest ways to earn a living. Therefore, it would be prudent to learn risk management in crypto trading.
Yet, the concept of risk management in crypto trading is poorly understood. Let’s learn how crypto trading risk can be managed by avoiding common mistakes.
Understanding Crypto Trading
A cryptocurrency is a virtual digital asset (VDA) that operates on a decentralized blockchain. Crypto trading involves buying and selling these digital assets on popular crypto exchanges such as CoinSwitch.
A trader of financial assets will make money when the market is volatile. The crypto market is known for its temperamental nature and volatility. This swing in the market offers potentially profitable opportunities to traders. However, market volatility also poses risks, and trading risks are amplified by leverage traders.
This is why aspiring crypto traders and existing ones should have extensive knowledge of risk management in crypto trading before putting money on the market.
Top Risks in Crypto Trading
Understanding the types of risk associated with crypto trading will help traders devise strategies to minimize risks. Here are some of the most common risks associated with the crypto market:
- Market Sentiment and Volatility Risks
Crypto markets are still developing, making them highly reactive to new developments. The volatility in the market can eat up your gains as well as your capital.
Trading is profitable for traders who can read market movements. Predicting crypto market moves is extremely difficult and poses the risk of loss to traders.
- Lack of Regulation
Crypto markets are unregulated across the globe. Unregulated markets make traders vulnerable to fraud and scams. To make matters worse, they don’t have legal recourse.
Pump-and-dump scams, insider trading, rug pulls, etc, are rampant in the crypto market, especially with news tokens and less popular altcoins.
- Security Risks
Cryptocurrencies are stored digitally and the lack of regulations in the crypto market makes them prone to hacks, thefts, scams, and phishing attacks.
Another common security risk for crypto traders is losing their private keys. This is because your private key safeguards your crypto assets and losing it would mean losing your assets permanently.
- Market Manipulation
Crypto whales are those who hold a large amount of a particular token. These individuals have the power to manipulate the price of the crypto as the token has low liquidity. Thus, they can influence the demand and supply balance with their buy or sell decisions. The price fluctuations resulting from market manipulation can prove costly for traders.
- Emotional Trading
Emotional trading decisions such as intensive buying when the market is at its peak because of the fear of missing out on profits (FOMO) or panic selling when the market is correcting can lead to significant losses.
- Lack of Understanding
Crypto trading is not the same as equity trading. A reasonable understanding of the crypto market and a good grasp of blockchain technology can lead to better trading decisions.
Read on to learn more about efficient risk management in crypto trading so that you can use the techniques to minimize your trading risk.
Efficient Risk Management in Crypto Trading
Risk management is the foundation for crypto trading. Traders need to design trading strategies to minimize risks and maximize returns. Crypto traders should look at managing the following risks:
- Capital preservation
An efficient crypto trading strategy should be such that it minimizes loss and the traders should be able to predict the maximum loss from the trade. A trading strategy with unlimited loss can wipe out the trader’s account in case of extreme volatility.
- Emotional Control
Crypto traders should be calm and composed and stick to their strategy, come what may. Impulsive decisions driven by fear and greed can lead to losses.
- Sustainability
Crypto trading strategies based on proper risk management techniques will allow the trader to participate in the market longer.
Best Risk Management Strategies When Trading Crypto
Risk management techniques in crypto trading will help traders reduce risk by improving their overall trading outcome. Here are some popular risk management strategies for crypto traders:
- Choose a Reliable Crypto Trading Platform
Security of your funds and digital assets is important when trading in crypto. Thus, choosing a reliable trading platform with an established track record like CoinSwitch Pro can benefit crypto traders.
- Do Your Own Research (DYOR)
The crypto market is flooded by “crypto experts” who offer foolproof trading strategies. Don’t get carried away by such ads promising exorbitant returns. Always do your own research (DYOR) before formulating a trading strategy. You can base your research on technical analysis, fundamental analysis of the particular token, and the overall sentiment analysis of the crypto market.
- Set a Trade-Specific Risk/Reward Ratio
Fear and greed are the biggest enemies of trading. Setting a risk/return reward ratio for your trade strategies will help you minimize the impact of emotions on your trading outcome. This is because a risk-return reward ratio will help you know the exact exit levels for both upside and downside.
If your risk/return rewards ratio is 2:1, it means you will only place trade orders that have the potential of delivering twice as much profit as probable loss.
Let’s understand this with an example.
BTC entry price: $60,000
BTC take profit: $62,000
BTC stop-loss: $59,000
Here, the trader buys BTC at $60,000, hoping the price will rise to $62,000. However, the stop loss is set at $59,000. This makes the potential gains of $2,000 twice as much as the potential loss of $1,000.
- Configure Stop Losses On Your Trades
Stop-loss orders are a trader’s best friend. They help risk management in crypto trading by limiting a trader’s downside risk.
Stop-loss orders help passively manage risk as they trigger automatically once the trade starts moving in the opposite direction from where the trader intended it to be.
Let’s continue using the above example:
BTC entry price: $60,000
BTC take profit: $62,000
BTC stop-loss: $59,000
Here the trader entered into the trade with the expectation that the BTC price would appreciate. But, the BTC price starts to fall. In this case, the stop-loss will be triggered at $59,000. The stop-loss order helps traders curtail their losses.
- Determine Position Sizing
Determine the capital you are willing to allocate to each trade. You can follow the 1-2% rule. This means you will allocate 1 to 2% of your capital to a single trade. This will protect your capital in case of adverse market conditions.
- Determine Your Entry and Exit Strategies
Traders are advised to pre-determine their entry and exit strategies to implement risk management in crypto trading.
An example of an entry strategy is when a token breaks its resistance level or when it is trading below its 200-day moving average.
On the other hand, an example of an exit strategy would be when a certain price level is reached or when a token crosses a certain RSI.
- Avoid Excessive Leverage
Leverage trading is a trading method that allows borrowing to trade with an amount much larger than your capital.
Leverage trading increases your profit, but it can also magnify your losses. A 70% leverage trade will increase your gains by 70%, but it also wipes out 70% of your capital if the market tanks. Therefore, it is advisable to use a conservative level of leverage.
Common Risk Management Mistakes in Crypto Trading
A fool learns from his mistakes. A wise man learns from the mistakes of others. This is especially true for crypto trading as learning from your mistakes can cost you dearly.
We have listed some of the common risk management mistakes in crypto trading so that you can learn from the mistakes of other traders.
- Trading Without a Strategy and Goal
Aimless trading is a recipe for disaster. This is because human emotions of fear or greed will triumph over logic. This will either minimize your profit or maximize your loss.
- Using a Non-reputed Cryptocurrency Exchange
Using a non-reputed crypto exchange or an untrustworthy trading platform can be risky if it were to get compromised or hacked.
- Lack of Fundamental and Technical Analysis Knowledge
Crypto trading without understanding the fundamentals and technicals of the token can lead to losses. Researching the potential of a crypto project before starting to trade in its token is a must.
Conclusion
Risk management in crypto trading is easier said than done. Understanding the underlying risks is the first step in risk management. Crypto market volatility is one of the fundamental risks inherent in crypto trading. While risks in crypto trading cannot be completely avoided, this blog post has listed ways to manage risks stemming from market fluctuations and other factors.
