Risks are inevitable in the digital currency ecosystem, and this BGECrypto guide explores 5 top risk management tips for avoiding losses
Cryptocurrency trading has gained traction as more investors flock to the ecosystem. Despite this influx, experts say many traditional investors still need to accept crypto trading to participate in financial innovation. These investors fear the high volatility that characterizes crypto trading, which could lead to the loss of valuable funds.
Is There a Strategy for Risk Management in Crypto Trading?
Seasoned traders in the crypto space maintain that losses are bound to occur irrespective of strategies adopted. However, it is important for crypto traders, particularly new entrants, to be aware of potential risks and how to minimize losses.
BGECrypto, in this article, highlights 5 top risk management tips crypto traders need to know to avoid capital loss. The guidelines should allow each investor to research the digital assets they wish to invest in. It is also by no means exhaustive.
Some risk management guides that have helped crypto traders over the years. These strategies include diversifying an investment portfolio, managing position size, and using “stop-loss and take-profit orders.” Others include hedging investments and staying cautious and disciplined in crypto trading adventures.
Now let us dive deeper;
1, Diversify Investment Portfolio
This is an invaluable risk management tip. The saying, “Do not put all your eggs in one basket,” applies to all financial investments. The price volatility experienced by crypto assets makes this more noteworthy, as digital assets can take a deep plunge without warning signals. When an investor holds only one asset, any crash in the value of that asset may lead to severe losses.
However, diversification ensures that if one of the assets plummets in value, the profits from the other investments can help lessen the impact of loss. Diversifying could be across coins or sectors like Decentralized Finance (DeFi), NFTs, and stablecoins. This spreads the risk option across different crypto assets.
The year 2017 opened with Bitcoin’s price slightly less than $1,000. However, the market witnessed an unusual bullish run, later called the “crypto bubble.” Some investors who liquidated their positions in other digital assets to buy Bitcoin at $9,000, expecting a continued rise, suffered huge losses the following year.
After reaching a peak of $20,000 per BTC in December 2017, Bitcoin plunged to about $6,000 in April 2018. By December 2018, the world’s leading digital asset had dipped below $3,500. Interestingly, investors who diversified into altcoins such as Ethereum were better protected from the massive loss caused by the crypto bubble burst.
2, Manage Your Position Size
Managing position size means allocating only a small percentage of the portfolio owned to each active trade. When traders bet with all their owned assets in a single trade, they suffer irrecoverable losses if it goes against their plans. Hence, seasoned traders admonish investors to limit their exposure so they do not lose a significant portion of their total capital.
When the LUNA/UST collapse of May 2022 occurred, billions of dollars were wiped out from the market. Traders who had allocated large positions in LUNA or UST suffered terrible losses in the crash. Only traders who limited their exposure to small position sizes survived the devastating experience.
Despite this experience, some investors with a huge risk appetite continue to commit a large chunk of their capital in a single trade. Such investors live by the maxim, “The higher the risk, the greater the reward.”
As a top risk management topic, seasoned traders discourage this principle emphasizing it could lead to terrible consequences.
3, Safeguard Investment With Stop-Loss and Take-Profit Orders
Another top risk management tip that might prevent a trader from huge crypto loss is to use stop-loss and take-profit orders. This tool is set up to monitor the crypto market and automatically sell a crypto asset at certain predetermined prices.
It helps to manage crypto risks given the volatility of price of assets. Stop-loss order can help a trader avoid reducing the loss suffered when the price of an asset falls below a level. Usually, it prevents the trader from making decisions based on emotions. Notably, some traders may want to hold on to an asset with hopes of a quick rebound and ultimately suffer significant loss.
During the COVID-19 pandemic, a global market crash occurred in March of 2020. In just one day, the price of Bitcoin crashed by more than 40%. Those traders with stop-loss orders in place as their risk management strategy were able to minimize their losses.
4, Hedging Crypto Investment
Hedging is a proven risk management technique used by seasoned traders and traditional institutions. Investors engage in hedging by making a trade in another crypto asset which might move in another direction as the price of one’s asset. Although it is difficult to find a perfectly related asset to take a counter-position on, hedging on another asset can help offset possible losses in one’s primary holding.
A common method of hedging in crypto trading to limit risk involves derivatives. These derivatives could be options contracts, perpetual contracts or futures contracts. Options allows a trader to sell a crypto asset at a predetermined price, thereby limiting losses should there be a price drop.
Despite its advantages, hedging has its downside. Notably, hedging protects a trader’s crypto investment against market swings; however, it also limits the amount of profit available.
5, Be Cautious and Disciplined
All traders are humans. As humans with emotions, traders might get carried away when deciding about a crypto asset’s potential. The crypto space recognizes this and has terminologies such as Fear, Uncertainty, Doubt (FUD), and Fear of Missing Out (FOMO).
A trader who wants to mitigate risk in crypto trade should not let FOMO push them into investing with all their capital and forget to apply the “position size” technique.
Although risk remains unavoidable in crypto trading, caution can prevent significant losses. A trader must not assume all trades will result in profit. Preparing for losses will help traders invest only what they can afford to lose.
Risk management in crypto trading involves limiting exposure, preparing for volatility, and staying informed. The crypto markets can experience sudden, dramatic swings. Although no foolproof ways exist to prevent losses, these 5 top risk management tips help crypto traders minimize unexpected downturns.
Disclaimer: The information provided in this article is for informational purposes only. It does not constitute investment, financial, trading, or any other sort of advice. You should not treat any of BGECrypto’s content as such. BGEcrypto does not recommend that any cryptocurrency should be bought, sold, or held by you. Do your due diligence and consult your financial advisor before making any investment decisions.
