Risk management is a crucial – yet all too often ignored – aspect of trading. It becomes even more important when volatile markets such as cryptocurrencies, as prices can often spike or tumble within minutes.
If you can properly manage risk when trading cryptos (or any other market for that matter), you will be able to make money more consistently over the long-term. If you’re completely new to the world of cryptocurrency, it helps to get an overall understanding of the topic first. Here are a few simple rules to integrate into your trading strategies to better protect your capital and increase your overall profits.
Plan your trades ahead
Not having a trading plan with risk management rules is dangerous, as you could make money on several trades in a row, but then go and lose it all in just one trade. Having a trading strategy will protect you from experiencing such a scenario.
A trading plan is not different from any other plan you might work on. It is a detailed description of the way you plan to implement your trading activity, according to certain parameters you have chosen to follow. The main idea of a trading plan is to create a set of rules that you will adhere to during this process.
Adapt the size of your trading positions
The size of your trades should always be proportional to your trading capital, as well as to the actual conditions you’re dealing with, like potential higher volatility due to an upcoming technical event (such as Bitcoin halving). An optimal position sizing strategy will reduce risks.
A common rule is not to risk more than 3% of your capital on a trade. It’s important to be consistent with your position sizing strategy to avoid using more funds on a single position, just because you’ve made a few winning trades. Similarly, it’s all too easy to fall into the trap of increasing position size after a loss to ‘make up’ for the money you’ve lost on your previous trades. This can turn into a particularly destructive vicious cycle, especially if you make several losing trades in a row. Stay vigilant with your trade sizes, regardless of what happens on the market.
Set up stop-loss and take-profit orders
In trading, the higher the risk, the more you can make…or lose. To protect your capital, it’s best to know how much you’re willing to lose on a single trade (stop-loss) and how much you’re planning on winning (take-profit) before you open any trading positions. The risk/reward ratio is often used to determine these levels. While the risk/reward ratio depends on you, there are some common rules you can follow. For instance, many believe that the ideal risk/reward ratio is around 1:3, which means that for every $1 you’re risking, you’re expecting to make $3. Even if only 40% of your trades are profitable, you’ll still come out ahead if you keep to that ratio.
Many brokers also offer another type of stop-loss order that you might consider implementing in your money management strategy – the trailing stop. Often considered to be the ultimate tool for trend investors, trailing stops are a kind of stop-loss order. Designed as a dynamic stop-loss, the trailing stop automatically follows the markets when they go in your direction but stop in the event of a market reversal.
Know when to stop trading
Some trading strategies, like scalping or day-trading, have the potential to keep you in front of the screens for several hours in a row, as you get in and out of the markets in a matter of minutes (or maybe hours). This can be quite addictive, which can often trigger bad reactions and behavior (especially when losing money).
Trading without losing is inevitable – even the best investors in the world lose sometimes. Even still, accepting losses and taking responsibility for them isn’t always easy, especially if you’re in a losing streak. That’s why it’s important sometimes to get away from the markets and stop trading for a while. This will give you a breather and ensure that you’re not influenced by toxic behavior that will override your strategy (like revenge and trading out of boredom, or overtrading).
Control your emotions
Psychology is very often underestimated in this process, even though it is one of the most important factors in determining your trading performance. Emotions are even stronger when dealing with volatile markets, such as the cryptocurrency market. If your emotions aren’t under control, they’ll impact the way you manage stress, the way you conduct your analysis process, understand and use information, as well as the way you make trading decisions.
Boredom, fear, nervousness, excitement, greed, euphoria, or overconfidence are the most common emotions in trading. To better control these emotions and avoid them getting in the way of your trading, always stick to your plan. This can make all the difference between success and failure, so never let your mental state dictate your trading activity.
Don’t force yourself to trade if you’re sick, overly tired, if you’ve argued with your family, or if anything is weighing on your mind, as you won’t be at your best. Sometimes the best risk management strategy is just not to trade.
Remember that market conditions change quite quickly in the crypto sphere, so it’s important to be sure you’re ready and dedicated to your trading when you decide to trade. Knowing the basics is also a crucial first step – click here for a beginner’s guide to crypto trading. This will help you to fully implement your strategy and take advantage of every opportunity that arises in real-time.
It’s not complicated to prevent losses from getting out of control. You only have to stay focused, keep your emotions under control, and follow your management rules. If you do that, you’ll be well ahead of the market.