Crypto traders are usually eager to get into trading and start making money regardless of their account size and how to manage their funds. As a result, it is common for novice traders to gamble, looking for a jackpot, while caring little about practices that promote consistency. If this sounds like you, it’s time to look at some risk management practices that, if done right, will protect you and help you stay in the market without blowing your account.
What is Crypto Risk Management?
There is no doubt that you will encounter negative events when trading crypto. By negative events, we mean trades that go against the desired outcome, unusual price spikes, errors, and many other unpleasant events. Risk is normal in trading; every crypto trader takes risks. Crypto futures traders take on more risk as they tend to use leverage on a regular basis. Failure to follow proper risk management practices affects your trading balance and you may even lose all of your capital.
Risk management practices capture how you intend to manage your risks when trading. They protect you against the disadvantages of your transactions and allow you to control your losses. The rules will not only protect you, but they will also help you achieve your desired outcome when the right crypto trading strategies are in place.
8 Crypto Risk Management Practices
Below are some risk management practices that you should apply to your transactions.
1. Have a solid trading plan
One of the biggest mistakes you can make as a trader is to start trading based on your gut feeling or instinct. We cannot deny that you can achieve positive results this way, but it can only be the result of luck and nothing more. You need a proper plan to manage your risks and achieve consistent results.
Your trading plan is your organized approach to trading. It’s a system you’ve created through your experience in the market to give you the coverage and results you desire. Your trading plan should cover when to open trades, close trades, how much risk you should take per trade, your risk/reward ratio, and more. Having all of these things planned out makes trading easier for you and helps you manage your money well.
2. Only invest what you can afford to lose
This is an often overlooked aspect of trading because many traders mistakenly believe that nothing can happen to them and that they have everything under control.
The question is, why should you follow this rule? As a simple answer: because you can lose your capital. Additionally, trading an amount that you cannot afford to lose will cause pressure and emotional stress, which can jeopardize your decisions and lead to more mistakes.
The crypto market is volatile and it is best to only trade a small portion of your disposable income. It is painful to lose money and even more painful when the money is destined for another use. For this reason, your trading capital must be sustainable.
3. Size your positions
The idea behind position sizing is that you need to measure how much you are risking per trade. You should not risk 100% of your capital on a single trade. Successful traders prefer to risk a fixed percentage of their capital per trade.
Some trading experts recommend that traders, especially beginners, risk no more than 1% of their account balance on a single trade. This practice will help you limit your risk and give you control of your trading capital. Some traders consistently risk 2% per trade and others 3% per trade. Some also believe in having no more than 5% of their capital in open trades, no matter how many opportunities they see.
Unexpected price fluctuations occur in the market. If you are risking more than you can bear, such fluctuations could cause you to panic and make you make irrational decisions.
4. Limit the use of leverage
Leverage allows you to trade using borrowed capital. As a result, your profits can be magnified, but so can your losses. The latter raises the need to understand how leverage works, how it impacts your trading results, and how best to manage it.
Futures traders are often tempted to use very high leverage to make a lot of money. But unfortunately, they forget that a small mistake can also push them into deep losses.
5. Always calculate your risk-reward ratio
The risk/reward ratio refers to the risk relative to the potential return expected from a trade. You should measure the risk/reward ratio of a trade before executing it. If you can determine the potential outcome versus the risk, you are more likely to opt for trades with a high probability of success.
When calculating the risk/reward ratio, traders usually opt for a ratio of 1:1.5 to 1:3. A ratio of 1:1.5 means that the profit target will return an amount 1:1.5 times greater than the risk. Any trade that closes at 1:1 is expected to break even, as there is no profit or loss, while any trade with a risk/reward ratio of less than 1:1 should not be executed.
6. Use the Stop Loss Order
The stop loss order allows you to specify an exit point on the market. This limits your losses when a trade goes against your prediction. You will have losses at some point, and there is nothing you can do about it. You can control losses by using a stop loss order every time you trade.
Some people think they don’t need to put a stop loss because they know the right time to exit the market. However, they forget or don’t know that the market is full of surprises and could easily get distracted. Also, not having a stop loss order makes it difficult to predetermine how much you will lose in a bad trade.
Stop losses help ensure that you don’t exit trades too early and miss out on potential profits. They also protect you from emotional trading and subsequent cognitive biases that can lead to poor decision making.
7. Secure your profit with Take Profit
Take profit works the same way as stop loss, the main difference being that it is used to secure the profit and not to stop a loss. The tool is designed to make a profit when the price reaches the specified point.
Having a clear expectation for your trading profit helps you predetermine the appropriate risk you should take. In addition, it will help you maintain discipline during exchanges.
8. Have realistic expectations
Having realistic expectations is key to managing your risk. You can’t make a 40% monthly profit without risking too much of your capital. Having such a goal will always force you to over-trade or use too much leverage, which could lead to massive losses. Setting more realistic goals will help you control your trading emotions such as greed, fear, and hope.
These practices are important
Risk management is very important for successful trading, and it should be taken seriously by both new and struggling traders. As simple as they may seem, not having them in place can get you into trouble in trading.
The difference between successful and struggling traders is not always in the trading strategies used, but rather in their simplicity. Successful traders are usually fairly straightforward in following their trading plans and have established risk management procedures which they consistently follow.
The information on this website does not constitute financial advice, investment advice or trading advice, and should not be relied upon as such. MakeUseOf does not give advice on trading or investment matters and does not advise buying or selling cryptocurrency, ever. Always perform your own due diligence and consult a licensed financial adviser for investment advice.