Risk management in cryptocurrency: In other words, “the art of not losing all your money”
Risk management is a vital element for a trader to successfully trade in any market. Whatever the size of the capital you trade or invest, losses are inevitable, especially in highly volatile markets like cryptocurrencies. Learning how to manage risk is essential to minimize losses. It is also necessary to master risk management to ensure a maximum gain. After all, the more willing you are to take the risk, the greater the potential return.
Risk management to avoid losses in cryptocurrency.
Even seasoned traders with an impressive track record of reading the market can lose everything in one or two bad trades if they don’t use proper risk management. The temptation to “hit the jackpot” or chase market sentiment can be strong and cause traders to be confused or overconfident.
At the very least, very basic trading tools and forms of risk management should be used to avoid big losses and be able to trade calmly. These consist of trading rules such as market orders, limit orders, and stop-loss orders that allow traders to limit their losses by triggering an action when certain conditions are met.
Using such mechanisms, traders can step away from the screen a little and trade with confidence, knowing that they can either limit their losses or take profits at an acceptable level.
The limits of that depend on the investor’s risk appetite and the amount of capital he is willing to lose on a particular trade.
Another way to manage risk is to keep a portfolio spread over several assets. It’s one of the golden rules. It gives protecting losses and ensures that one bad investment does not destroy all your capital.
Risk management to maximize your earnings.
We’ve seen astronomical growth in the cryptocurrency space over the past year, with incredible gains from most major cryptocurrencies. Decentralized finance fueled the passion for yield farming. It also provided an attractive passive income on crypto assets and provided a borrowing and lending ecosystem away from traditional finance. Investors began to return to the crypto space in droves.
This year, we’ve seen a lot of support from companies like MicroStrategy, Guggenheim, PayPal, and Square in the crypto world. Bitcoin (BTC) has skyrocketed this year and has more than doubled its previous all-time high thanks to the action of the institutions. MicroStrategy has given the rise a big boost, buying more than 70,000 BTC last year.
How to prevent losses and trade safely
1. Don’t put all your eggs in one basket. If you invested your entire deposit in one cryptocurrency, and it suddenly dropped by 50%, you would lose half of your investment. But what if you had ten assets, and Ripple was only 10% of your entire deposit? Then your loss would be less significant. Therefore, never ignore risk diversification! Always analyze the market and invest in different cryptocurrencies.
2. Estimate the size of the trade. Often, traders are guided by emotions other than logic or serious calculations. There’s even a special term that complements what we’re saying. It’s called FOMO, or fear of missing out.
Inspired by the scam, novice traders put 30–40% of their deposits in a single deal and suffer serious losses when the deal fails. So don’t forget the 6% rule and the 2% rule.
The latter states that you should open a position with no more than 2% of your entire deposit. Some even recommend investing no more than 1% of the deposit. By using this strategy, you will never drain your entire deposit.
The 6% rule says that if you keep losing money in crypto trading and can’t stop the series of unsuccessful trades, you should stop trading if you lose more than 6% of your deposit. In this case, it is recommended to take a break from trading for 1.5–2 weeks so that you can psychologically recover and stop making rash decisions.
3. Determine transaction profitability. Remember that not all trades will be profitable. Even professional traders lose money. Losing is a part of trading, and you have to accept it.
The main thing to consider is the profit/loss ratio. Ideally, it should be 3 to 1, or at least 2 to 1.
The top newbie traders mistakes
Learning from your mistakes is a great but, at the same time, a very expensive way to succeed. Therefore, we have created a list of the top three mistakes of beginner traders.
The deal turned out to be unprofitable, and the trader lost money. And then comes the desire to recoup everything as quickly as possible to compensate for the losses. This, of course, leads to rash decisions and even greater losses. Never act this way! Record your losses and don’t be blinded by greed.
Self-confidence is an important skill, but overconfidence can play a dirty trick on you, especially when it comes to crypto trading. Even with the most professional forecasts, the deal may turn out to be unprofitable for you.
Another mistake that every newbie makes, which has already become a reason for memes, is the neglect of stop-loss and take-profit orders. Let’s start with the first one: a stop-loss order is an instruction to the exchange to close the trade when a certain price loss level is reached.
For example, let’s say you bought some ETH for $1,700. You conducted a technical analysis and assumed that the price of the coin would rise. However, we all know that the cryptocurrency market is volatile, and therefore, you need to protect yourself.
For that reason, you will need to place a stop order to sell your ETH. You give a command to the system that if the price of ETH drops, for example, to the $1,500 level, then it needs to be sold. Thus, you control your risks: even if the rate falls by 50% per hour, your loss will not be as significant.
A take-profit order is even more complicated. Very often, beginners do not know how to take profits and close deals when a certain level of profit is reached. Remember, greed does not lead to good outcomes. Determine your take-profit level in advance and close the position upon reaching it. The price trend can turn around at any time, and you will not only fail to earn but also lose.
I hope you learned today about risk management in the cryptocurrency world. To learn more, check out our other articles on our blog.
