Crypto Trading Risk Management
Updated: Apr 1, 2019
One of the main goals of trading (besides making profits) is to limit the amount of risk on each trade you take. You can do all the research and due diligence possible on a cryptocurrency and a trade you place may still not work out in your favor. For whatever reason, the market went in the wrong direction. It has happened to every single person who has ever traded regularly. However, what sets experienced traders apart is their ability to utilize risk management in their trading strategy. One risk management tool is the use of stop losses.
What is a stop loss?
A stop loss is essentially your “exit plan” in case a trade goes against you. It is an offsetting order which will exit you out of your position in a trade if a certain price level is reached.
For example, if you are looking at BTC/USD trading pair sitting currently at $7,645 and are expecting it to rise, you would possibly enter into a long BTC/USD trade at that price. To help limit your risk in the event of the price dropping, you could place a stop loss order at say $6,885 because your research and strategy indicates that if the price drops to that price point, the price could potentially continue to drop even further. So setting the stop loss at $6,885 could cut your losses to only $760 instead of potentially much more of you continue to hold onto this trade as the price continues to fall below $6,885.
Advantages of using a Stop Loss
Keeps you honest with your trading strategy. With every trade we recommend mapping where you will take profits, where you will get out of trades, etc. before making the actual trade. Without planning out your trades in advance, people tend to trade emotionally and will either assume the price will continue to increase and never lock in profits or hope the price will recover and never get out of a trade until it is too late. Utilizing a stop-loss will take the emotions out of your trading and prevent a bad situation from getting worse.
Allows you to take a break from trading. With crypto markets open 24/7, a stop loss will allow you to stay consistent with your trading strategy even when you are not sitting in front of your computer. Exchanges like Binance, HitBTC, Kraken, BitMEX, and more allow you to set stop losses on your trades so that when the price hits your stop loss, your order will be automatically placed to get you out of the trade before further potential losses can occur.
Ability to lock in profits along the way. Another use of stop losses is what is called a “trailing stop loss”. A trailing stop loss can be used during a successful trade to guarantee you exit the trade in the green. Say in our same example above that the price over the next few days has increased to $8,200. One thing you can do is set a stop loss above your purchase price of $7,645 so that if BTCUSD experiences a reversal before your take profit price is reached you will at least be able to lock in some sort of profit on that trade. And as the price continues to increase, increasing the price of your stop loss will enable you to continue to lock in more profits along the way.
Disadvantages of using a Stop Loss
The key disadvantage of utilizing a stop loss in crypto markets is the volatility associated with cryptocurrencies. Cryptocurrencies are subject to massive swings in price due to low liquidity, market manipulation, and regulatory news. Setting a stop loss in an extremely volatile market could close you out of a position too quickly and have you miss out if there is a short-term reversal back into profitable zones.
Taking a look at BTCUSD again with the chart above. If you were in the current trade around $7,640 and price suddenly plummets, and your stop loss was placed anywhere within that large red candle, you would’ve gotten stopped out and potentially taken a loss on the trade. However, without a stop loss, only a few hours later BTCUSD recovers with succeeding long green candles all the way to the top around $7,750. In this scenario a stop loss would’ve cut you out on an additional $110 (per BTC purchased) which could potentially be even more if you were utilizing leverage in the trade.
Recommendation
Due to the volatility in crypto markets, we feel the best strategy to be used is more of a “mental” stop loss. We fully believe in planning out your trades and setting price targets for when to take profits and when to limit your losses. However, due to the market conditions surrounding most cryptocurrencies the use of an actual stop loss order could potentially be more hurtful than helpful to your trading strategy. There are many different sites and apps that allow you to set price alerts for coins. We suggest utilizing those alerts to help within your risk management strategy. And if you do choose to utilize stop loss orders, make sure you do your research to pick appropriate price levels to place your stop losses. There are many advanced traders who prey on improper and predictable stop losses to profit off inexperienced traders.