Cryptocurrency trading has become hugely popular, as an increasing number of individuals look to generate consistent monthly returns from the market. This is generally an achievable goal given the number of trading opportunities that can exist in a volatile market like crypto. However, inexperienced traders often fail to beat the crypto market, and a large part of that is due to improper risk management strategies. Let’s take a look at some risk management strategies that you can employ when trading in the cryptocurrency market.
Stop Losses and Take Profit Targets
This is a very basic risk management strategy that every cryptocurrency trader should be using. Stop losses are designed to prevent traders from experiencing severe losses if they find themselves down on a trade. Whereas, profit targets are intended to make traders aware of the price point that they should be looking to take profit. These two risk management strategies are important because they force traders to be disciplined in their trading. For example, a trader with no stop loss is much more likely to trade emotionally and believe that the price will rebound in their favour if the trade has gone in the wrong direction. With a stop loss, such emotional trading is completely eliminated. Automated tools such as signal groups (e.g. crypto signals) and trading bots are also useful in helping to eliminate risk.
Another important strategy for risk management is position sizing. The idea behind this technique is that a trader should generally not risk more than 1% of their overall trading capital. The reason for this is to mitigate against overall losses that a trader can make. For example, if a trader makes 20 consecutive losing trades, they will still have 80% of their overall trading capital. Also, with position sizing, the trader will be using a lower proportion of their trading capital with each loss that they make. Position sizing also works great when a trader goes on a win streak, as they will be using a progressively high proportion of their overall trading capital if they were to go on a winning streak.
The backbone of any trading risk management plan is being able to assess the risk to reward ratio of a trade. Bad traders generally enter into trades that have a poor risk to reward ratio, which means that in the long run they will be at a net loss. However, good traders will only ever take trades that have a high probability of success aka a high risk to reward ratio.
The risk to reward formula:
(Target – entry) / (entry – stop loss)
Use the below as a guide when it comes to assessing the risk to reward ratio for your own trade:
- If it’s lower than 1:1 never place a trade
- 1:1 is breakeven
- 1:2 is great to trade
- 1:3 is even better and is an ideal ratio
To conclude, risk management is very important, especially in the crypto market. These are just a few risk management techniques that are popular amongst successful traders. Exploring the other techniques out there will set you on the right path to being an effective cryptocurrency trader.