Cryptocurrency trading offers the potential for significant rewards, but also comes with substantial risks. By implementing proper risk management strategies, traders can maximize their chances of being profitable over the long-term. This article outlines key techniques traders should use to effectively manage risk.
Have a Written Trading Plan
A trading plan is essential for managing risk. The plan should outline your:
- Trading goals
- Acceptable loss limits per trade and overall
- Entry and exit criteria for trades
- Position sizing approach
- Risk/reward ratios
Documenting these elements forces you to consciously think through how you will trade. It also provides guidelines to follow during emotional moments when you may be tempted to abandon your plan.
Follow your plan consistently, reviewing and updating it periodically as needed. But avoid changing your plan mid-trade simply because it feels uncomfortable. Stick to the criteria you defined in advance for managing that trade.
Only Risk What You Can Afford to Lose
Never risk money needed for necessities like rent or food. Only use disposable income that would not alter your lifestyle if lost completely. This helps avoid making emotionally-driven decisions due to feeling pressure to recoup losses.
Investing a small percentage of assets in cryptocurrencies provides exposure to upside potential while limiting downside risk. Determine an affordable level of assets to devote to trading. Then implement position sizing rules accordingly. For example, if you have $5,000 in disposable income you are comfortable putting at risk, you could deposit $2,500 on Bitcoin 360 Ai to trade cryptocurrencies with.
Use Proper Position Sizing
Position sizing means calculating how large or small to make each trade. This should be primarily based on your account size and risk tolerance. A common guideline is to risk only 1-2% of your account on each trade.
For example, if you have a $10,000 account, you should not risk more than $100 – $200 per trade. So if you lose that amount, it would only represent 1-2% of the account value, leaving you still with most of your capital intact.
Proper position sizing also helps avoid emotional pitfalls like revenge trading after losses. You are less likely to chase trades if you know you are adhering to a sensible risk limit.
Set Stop Losses on Every Trade
Stop losses automatically close a trade at a predefined adverse price level. Using stops locks in the maximum amount you can lose on a trade.
Set stop loss levels before entering each trade, placing them at technical or chart levels likely to invalidate your trading rationale if breached. Employing stops requires accepting and planning for the possibility of stopped out trades. Manage trades according to your plan’s stop loss criteria, rather than moving stops during a trade or deleting them altogether.
Stops are essential because you will not be able to predict every trade correctly. Pre-defining stop levels keeps losses contained and gives trades room to move in the intended direction if your analysis proves correct.
Target a Minimum Risk/Reward Ratio
The risk/reward ratio compares your potential profit versus potential loss on a trade. A 1:2 risk/reward means your potential profit is twice as large as your potential loss. Higher reward ratios are preferable when trading.
As an example, if your stop loss amount is $100 on a trade, look for trades with the potential to gain at least $200 (a 1:2 risk/reward). This may require waiting patiently for such a trading opportunity to arise. Avoid taking trades where you risk $100 to make $110, as even winning more than losing would only generate small returns.
Requiring a minimum risk/reward ratio tilts the probabilities in your favor over many trades, and ensures you get paid appropriately for the risks taken.
Be Wary of Leverage
Leverage allows controlling large currency positions with only a small capital outlay. But leverage significantly amplifies losses when trades move against you. Limit leverage usage to levels you feel completely comfortable with based on your account size and risk tolerance.
Monitor the leverage ratios of your open positions. As the total leverage amount approaches your maximum comfort level, avoid opening additional leveraged positions. Doing so exposes you to potentially devastating losses from normal market fluctuations.
Using excessive leverage in an attempt to win back losses almost never ends profitably. Price moves quickly wipe out accounts with high leverage during times of market volatility.
Have a Trade Management Plan
It is human nature to hold on to losing trades in hopes they will reverse course. Similarly, winning trades often get managed more loosely, allowing open profits to dwindle. Both behaviors can turn winning trades into losers.
Define clear trade management rules for both winning and losing trades:
- For winning trades, set targets to take partial profits along the way up to reduce open position risk. Move stop losses to breakeven at a defined point. Trail stops incrementally to lock in profit as the market moves favorably.
- For losing trades, stick to the original stop loss level defined for the trade. Don’t delete or move stops farther away when a trade feels scary. Accept a loss according to your trade plan criteria rather than hoping the market will turn around.
Consistently following predefined trade management rules provides the discipline required to succeed long-term in trading.
Focus on High Probability Opportunities
Beginners often think they must trade frequently to make money trading cryptocurrencies. But overtrading causes you to end up in low probability trades, as you feel compelled to always be in the market.
Instead, wait patiently for setups that meet your trading plan’s entry criteria. Some days may see no trading opportunities arise that match your plan parameters. That’s alright – stand aside rather than taking trades you feel lukewarm about. This avoids needlessly giving back capital on low probability trades.
A few quality trades with favorable risk/reward potential based on predefined criteria will outperform dozens of mediocre setups over the long run. Stay picky and patient.
Keep Emotions in Check
Fear and greed are the enemies of most traders. Implementing and sticking to the risk management techniques described above helps greatly in defeating these emotions. But also:
- Trade small – Trade a size where losing on a trade does not impact your psyche or financial situation. Take time to prove your strategy works consistently before increasing position sizes.
- Take breaks – Step away after hitting pre-set loss limits for the day or when on a hot streak. Never trade in emotional moments.
- Stay balanced – Don’t allocate such a large percentage of assets to trading that it creates anxiety over losing. Maintain diversified investments and a cash reserve for other goals.
- View losses objectively – Losses are a natural part of trading. Expect them and learn from them. Don’t take losses personally or let them affect your confidence.
Implementing strong risk management strategies takes some work upfront. But doing so will provide the foundation for trading like a calculated professional rather than gambling recklessly. Your trading account balance will thank you.
- Define and follow a written trading plan with risk management rules
- Only risk a small percentage of assets per trade
- Use proper position sizing based on account size
- Utilize stop losses on every trade
- Target a minimum 2:1 risk/reward ratio
- Limit your use of leverage
- Follow predefined trade management tactics for wins and losses
- Wait patiently for high probability trading opportunities
- Keep emotions like fear and greed in check
Proper risk management leads to long-term trading success. Ignore it at your own financial peril. Take the time to implement structured risk practices, stand by them during difficult moments, and your trading results will dramatically improve.
About the Author
Temitope Olatunji is a 10 year trading veteran and cryptocurrency expert. He specializes in teaching beginners proven risk management techniques to generate sustainable trading profits.