Learning the Risk Management in Crypto Trading

Risks and losses are an integral part of crypto trading, whether you are an experienced trader or working your way up. The versatility of the crypto market is a challenge not everyone is up for. Even expert crypto traders lose money occasionally. However, with the proper risk management plan, failures can be avoided, and wasting assets can be reduced to a safe minimum.

 

Rule No.1 when taking a risk in the crypto world is to anticipate it always and not to risk more than you can afford to lose. Following this rule is what makes pro traders so successful in their efforts to make a profit. They know that trading is a complex process that involves a lot of thinking and self-control. You won’t get rich overnight by spending everything you have. Usually, the outcome is the complete opposite of that. 

Taking a reckless risk will leave you with more losses than profits. Therefore, you ought to have a risk management strategy to support you when the market abruptly changes. 

 

Understanding Crypto Trading Risks

A risk in crypto trading represents the possibility of something negative happening, such as an undesired outcome resulting in substantial losses. The thing about cryptocurrencies is that risks are everywhere, and it would be very unwise to overlook them in your trading strategies.

To better understand them, there is a distinction between four essential financial risks that are most widespread in crypto trading. 

  • Credit risks – the crypto industry is not immune to this type of risk, which happens when the party behind a cryptocurrency project doesn’t fulfill its obligations. 
  • Liquidity risks – it’s the risk of not being able to convert the whole position to fiat assets. 
  • Market risks – the risks that come with the constant movements of the market. 
  • Operational risks – when due to operational issues, traders cannot trade, deposit, or withdraw their assets. 
  • Legal risks – usually related to regulative and legal issues of a particular country. 

 

 

Risk Management Strategies 

Several methods can help you with taking a calculated risk and avoid losing all of your money by making bad decisions on the crypto market. The following ones are essential for expert traders who want to reduce their losses and improve their strategies, but can also be quite helpful for the newcomers. 

 

#1 Position Sizing

Diversification is fundamental in crypto trading. Sometimes, market prices can be tempting. If a cryptocurrency is showing excellent returns and marks a substantial price growth, traders driven by the bullish markets and FOMO will invest all of their trading capital in one separate deal. That is an immense mistake that will most likely lead traders to enormous losses. Nevertheless, they can easily avoid it by taking the proper position size on each trade.  

 

Enter Amount vs. Risk Amount 

These two are separate amounts, one of which applies to how much money you invested in a deal, and the other one represents the money you put at risk if your strategy fails. We will explain the risk factor further in the article. Right now, it’s crucial to understand what the entered amount represents. There is an exemplary equation that can clear this up for you. 

Entry Amount = ((Stack Size x Risk per Trade) / (Entry Price – Stop Loss)) x Entry Price

 

Risk Per Size and Per Session 

According to professional trader Alexander Elder, there are two rules when you want to take a risk. He suggests limiting the risk per trade to two percent only, and per trading sessions to six percent. When you reach that level, it’s best to stop there and take a break for the day before losing more of your assets. 

These boundaries help traders minimize their losses, without putting themselves in a situation where they encounter a tremendous failure that will be hard to overcome. 

 

Long-Term Trading Strategy – Kelly criterion

The Kelly criterion (Kelly formula) is one of the most appreciated ones for long term trading. Thanks to its unique approach, over the years, the formula brought profit to many traders who used it. 

Risk Amount = (Success % / Loss Ratio at Stop Loss) – ((1 – Success %) / Profit Ratio at Take Profit)

The bet sizing formula dates back to the 50s and leads almost always to substantial wealth, although it’s very intricate. Overall, it helps traders calculate the capital’s percentage to bet frequently. After applying it to your trade, the formula helps you determine the percentage of your entire invested capital, which should not be surpassed and risked if you want the best outcome.

For those of you who find the Kelly formula to be difficult, we advise you to stick to the previous one and set an enter amounts to define the risk. 

 

 

#2 Risk-Reward Ratio

The second concept as part of the risk management strategy that needs to be addressed is the risk-reward ratio. It depicts the correlation between the actual level of risk and the potential returns of a trade. It goes without saying that the higher the risk, the bigger the profit will be. However, this also suggests that traders have a high probability to lose the assets if they make the wrong move.

There is a formula crypto traders can use to define the relation between the risk and the award. 

Risk/Reward Ratio = (Target Price – Entry Price) / (Entry Price – Stop Loss)

It’s quite simple yet very beneficial and insightful.

If the results show a lower than 1:1 ratio, it means the trade should not happen. Only invest if the proportion is at least 1:2 or higher. 

 

 

#3 Stop Loss and Take Profits

Finally, one last thing you need to know regarding risk management is the Stop Loss order. It’s an excellent feature, also offered by automation crypto trading terminals, which allow traders to close a trade after the price declines up to a specific point.

Take Profits, on the other hand, represents an option in crypto trading to close open orders when the prices increase to a specified limit and coins reach the value the trader was leaning towards. Both are excellent alternatives to making a smart trade and minimizing losses. The best thing about the orders is that you don’t have to control them manually. Automated trading platforms such as Superorder offer these excellent risk management assets. They convey all the manual work from traders to algorithms that follow the market’s prices and execute the orders when the prices reach a certain high or low. 

 

 

Strategies and Advice to Help You with Your Trading

Although they might appear complicated, having a diverse portfolio, following the risk/reward ratio and setting up precise orders is a must-have in your risk management strategy. They are crucial for the growth of your asset portfolio.

However, there are several other things you can take into consideration and include in your crypto trading. They are often disregarded by traders, even though they can make a difference and help crypto traders excel in their trading. 

 

Keep an Eye on Fees

Crypto trading can turn out to be more expensive than you think if you don’t keep an eye on all the fees you are paying. Before starting the trading strategy, it’s best to make a thorough research on things such as deposit and withdrawal fees, leverage fees, etc.

 

Measure Drawdown

A drawdown represents the total decrease of the funds you initially invested, after experiencing several fails in your trading. Don’t allow the drawdown to reach more than five to six percent of your initial investment. 

 

Try To Maintain a Win Rate of At Least 50%

It’s easier said than done. However, for successful trading and maintaining a steady growth of your portfolio, try to have more earnings than losses. If your losses climb higher than 50 percent, you are most likely to lose your money because of a bad strategy and lack of risk management. 

 

Accept Failures 

Finally, the last advice would be to accept failures. They are bound to happen, especially in the crypto trading world. It’s practically impossible to win all the time, although if you have a good plan and stick to it, the chances of you winning will likely increase. Even expert traders fail, so don’t be disappointed when this happens but make sure you don’t make the same mistake twice.

 

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