What is risk management in crypto trading and why is it important
95% of crypto newbies lose money. The main reason behind this is poor risk control skills that may lead to impulsive decisions. That’s why risk management is one of the most important aspects of cryptocurrency trading, and how to use it to avoid draining your deposit on the very first day.
Risk management in crypto trading
The cryptocurrency market is growing at a crazy pace. The beginning of 2021 illustrates this beautifully. According to CoinMarketCap, the total capitalisation of the cryptocurrency market exceeded $1.36 trillion on 9th June 2021. Just to compare, back in March 2020, the market capitalisation was estimated only at 160 billion.
As the market continues to grow rapidly, many people forget that crypto trading is not only about profits, but also about risks. And if you don’t want to drain your deposit on the very first day, you have got to keep risk management rules in mind. The right strategy will help you to make a huge profit and decrease the risk of potential losses.
In cryptocurrency trading, risk is the likelihood of losing invested funds. Therefore, risk management is the ability to predict and control possible losses from an unsuccessful transaction.
Why is risk management so important? Here is a simple example. You decided to invest in cryptocurrencies and bought Ripple, a relatively strong and stable project, for your entire deposit.
But unexpected things happen when you least expect them to happen (sarcastically) — XRP dropped. And dropped by as much as 50%. By the way, these are not abstract numbers. Just take a look at Ripple’s chart for the last year and you will see continuous ups and downs.
To sum up, you can lose half of your deposit just by carrying out one single deal. Of course, this is a very dramatic example. Even beginner traders rarely make such obvious mistakes.
But the bottom line remains the same: if you don’t have a risk management strategy and are trading intuitively, you will definitely be losing money.
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 analyse the market and invest in different cryptocurrencies.
2. Estimate the size of the trade. Very often traders are guided by emotions rather than logic or serious calculations. There is even a special term that describes this phenomenon. It’s called FOMO, or fear of missing out.
Inspired by the hype, beginner traders behave recklessly, investing 30-40% of their deposit in one deal, which can lead to serious losses when the deal fails. Therefore, don’t forget about 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 in trading for 1.5–2 weeks, so that you can psychologically recover and stop making rash decisions.
This principle is closely related to the capital loss limit. When you enter a position, make sure that the total risks for all orders do not exceed 25%.
This provides a guarantee that if all your trades turn out to be unprofitable, you will still have at least 75% of the deposit.
3. Determine transaction profitability. Remember that not all trades will be profitable. Even professional traders lose money. Losing is a part of trading, you simply 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.
On the EXMO exchange, we offer an Analytics section to help you easily track your profitability. You don’t need to make manual calculations. Just open Analytics and you will be able to form an effective trading strategy.
Top 3 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.
Standard situation: 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.
Often, it’s self-confidence that makes traders invest 30-40% of their deposit. They are sure that Bitcoin will definitely go up in value. But we are not so sure. Therefore, build the right strategy and do not risk a large amount of your deposit.
Another mistake that every newbie makes, and 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 a 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 on EXMO. You give a command to the system that if the price of ETH drops, for example, to $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.
