Risk management is very necessary for any kind of investment. It helps to lower the negative results from your trade. You can maintain the probability of negative results of crypto trading through this approach. Recently, NYSE allowed Bitcoin’s ETF for trading, and the value started soaring right from the moment the news breakout.
But what you need to know is that such sudden spikes and this kind of news would not trigger you to take actions that can cause irreparable loss.
Market sentiments can easily trigger the mindset of investors or traders of any asset class. These days crypto trading is gaining the attention of mainstream traders. But it would be good if you approach crypto trading with proper Risk Management in Crypto Trading to reduce the potential losses and earn higher returns.
What is risk management?
Risk refers to the chance of undesirable outcomes related to your trade. Approach crypto trading in the long run by managing your positions carefully. One of the most crucial tools a crypto trader should master is the risk-to-reward ratio.
Risk is an essential component of trading. Knowing how much risk you’re taking on each trade is one method to keep your capital safe. The percentage shows how much you’re risking in relation to the potential profit.
Many traders disregard the guideline of risk-reward ratio because they assume the ratio is irrelevant, yet it makes all the difference in the end. Each trade entails a certain level of risk, and you must be informed of the level of risk involved before joining a trade.
Types of Risks
The Crypto trading fraternity is exposed to various financial risks. But here we are talking about the most common ones and significant risks that you should avoid and take into account while conducting Risk Management in Crypto Trading
Legal risk
The possibility of a negative event occurring in relation to regulatory laws is referred to as legal risk. For example, a country-specific restriction on bitcoin trade. You can observe the recent crackdowns by the Chinese government on crypto trading. Typically, the best crypto exchanges have greater trading volumes, as this is where the majority of consumers and institutions trade.
With the general public’s growing interest in the cryptocurrency market, it’s becoming more common to come across unregulated frauds, which have led to numerous victims falling into their traps. In addition, the lack of transparency in terms of the regulatory and legal framework is another significant concern associated with cryptocurrency.
As a result, in order to have a secure trading environment, you must identify trustworthy crypto exchanges and crypto-wallets.
Technological risk
Many articles have been written regarding bitcoin mining’s computational difficulty and energy usage as an example of some of the cryptocurrency’s technological limits. As a result, investors should be wary of technological risks and decentralisation promises made by numerous projects because not all blockchains are created equal.
However, not all cryptocurrencies or tokens follow the same path. This computational complexity may also work in the other direction, posing potential threats to the asset class. The decentralised nature of true blockchain systems provides intrinsic catastrophe and risk protection that centralised databases do not.
Cyber risk
In terms of traceability and levels of trust, not all cryptocurrencies are created equal under this standard. Cyber risks are significant in crypto trading. While the bitcoin blockchain has shown to be one of the most cyber-resistant developments to date, the companies that plug into it, like other cryptocurrencies, are frequently newcomers with lax cybersecurity standards and resources.
Liquidity risk
Liquidity refers to how easy it is to enter and exit a market without experiencing significant slippage. However, exiting the trade at the targeted price will be difficult if an asset has insufficient liquidity when demand and supply are restricted.
Market manipulation
Market manipulation is also one of the greatest risks in crypto trading. Social media influencers, prominent market players, financial organisations can affect the mindset of the traders. But there are some frauds and harmful elements in the market that can manipulate the conditions and try to drive the market as they want.
How to calculate the Risk-Reward ratio?
First and foremost, you must place your stop loss and profit orders. Once this is complete, you may calculate your Risk Reward Ratio using the formula below:
Risk reward ratio = (Target price – Entry price)/(Entry price – stop loss)
The trader must wait for the optimal setup to materialise, as a good setup usually contains a decent risk-reward ratio, and the reward is well worth the wait. It can take some time to find the proper risk-reward ratio deal, but patience is crucial here.
Ignore the trade where the risk-reward ratio is less than 1:1 as you may rapidly lose money in such trade.
Risk Management in Crypto Trading strategies
Regulation
If regulatory permission is obtained, it will improve and indicate both acceptance and legitimacy among the bitcoin community. Choosing a regulated broker or any crypto trading platform is the preliminary step of risk management in crypto trading.
Regulatory clearance appears to be the most significant reduction of the inherent risk associated with cryptocurrencies, which is ironic given that cryptocurrency is a decentralised currency with no regulatory supervision or framework.
Ease the process through global organisations
With so many institutions adopting new technologies, you can look for a better way to stand out than to promote a cutting-edge digital currency or at the very least provide assistance to its consumers as a service.
When global organisations came together to project cryptocurrency trading more legitimately, then it would become the most significant factor for risk management of crypto trading. This degree of acceptability will be possible if consumers have access to cost-effective and simple-to-use new offers and services via digital technology.
The responsibility is enclosed within a higher degree of accountability to consumers in terms of getting better information, portraying improved availability, increased cash exchange reliability, and providing a reasonable level of effective consumer protection.
In addition, being the first to market with a suite of cryptocurrency-related services would strengthen the company’s reputation and foster a culture of technological innovation.
Right Capital allocation
Diversify your portfolio since it will present you with additional trading possibilities if you have a larger exposure to multiple markets and instruments. When it comes to trading risk management, diversification involves sticking to more than one trading technique.
Right capital allocation is necessary for risk management in crypto trading. Finally, diversification involves having a more balanced risk profile in order to maximise returns over time.
Because the market is continually in motion and the market environment is constantly changing, this plays a huge role in risk management. So instead, arm yourself with the knowledge to deal with trade-offs if your position takes a turn for the worst. In the end, the chances of suffering a substantial loss due to merely one unfavourable movement will be averaged out.
Position sizing
Never put all your eggs in one basket, as the saying goes. A trader’s position sizing determines how many coins or tokens of cryptocurrencies they are willing to purchase. The magnitude of a transaction or a trade-in bitcoin trading is referred to as position sizing. You must consider an appropriate stop-loss level when determining the best position size.
Your risk tolerance and account size always determine the size of the stake. The risk tolerance, which must be defined in advance in the trading strategy, determines how much you are willing to risk per trade.
Traders are enticed to deposit a large part of their trading capital in crypto trading due to the possibility of making large returns. However, this is a risky strategy that puts your finances in jeopardy.
Exploit the price volatility
The use of bitcoin has exploded, as has the potential of people to harness the power of technology. Increased liquidity would aid cryptocurrencies in acquiring qualities more akin to widely recognised fiat currency. In addition, the mobile phone has boosted knowledge, transferability, and know-how, particularly in emerging markets.
It would also reduce price volatility, lowering exchange-rate risk and easing the pressure on risk-averse merchants and consumers to convert cryptocurrency back into fiat currency as soon as possible. We may see increased liquidity as the cryptocurrency industry develops and matures.
Tighter bid/ask spreads and lower exchange costs would result as a result of this. In addition, the advent of Internet banking, greater consumer use of alternative payment methods such as Apple Pay, Amazon Pay, PayPal, etc. and advancements in mobile payment technologies have paved the road for the acceptance of bitcoin.
Expect tangible returns
The expected return can be calculated as a percentage of the risk. Typically, target zones are established based on the market structure, which includes supply and demand. As a result, the good trades will offset the lost deals, leaving significant profit margins.
A lucrative trading strategy seeks scenarios with a high risk-to-reward ratio and a reasonable win percentage. Typically, an efficient trading risk management system’s equity curve. Because the profit levels are higher, it is usually smoother on the upward. In addition, many expert traders utilise risk units to indicate prospective targets and determine whether or not a deal is worthwhile.
Utilise multiple timeframes
Professional traders usually take a top-down approach, focusing their study first on larger periods and then filtering the market signals by seeking for trades in smaller time frames. As a result, we may expect a strong retracement to the downside based on that extension, and we can seek for clues to trigger a short entry in the hourly chart.
Multiple time frame research helps avoid tunnel vision because it’s all too easy to get caught up in a single time frame and miss the bigger picture of the market trend. This is the outcome of looking at the situation over a longer period of time.
Let’s take an example where we can observe that the price has extended upward in an hourly time frame, with consecutive bars up without any corrective action. Furthermore, the effective application of different time frames frequently results in instances where the risk is minor compared to the potential benefit.
Now let’s assume that the price drops quickly after a sudden movement is triggered. The price can make a shooting start after failing to breach the previous swing high in the hourly chart, which is the perfect entry to play the first lower high in the chart.
Stop Loss
To minimise significant losses and reduce disaster risk, it is usually a good idea to put a stop-loss order. It is the most important instrument for risk management since it allows the investor to handle trades when the outcome is unexpected properly. Stop-loss is a type of order that will enable you to cut your losses on losing trades.
Bottom Line
Risk Management in Crypto Trading strategies mentioned in this tutorial will help you stay in the game for a longer period of time. In addition, some of the dangers connected with crypto exchange risks will be eliminated as global efforts to promote cryptocurrency usage gain steam.
You can eliminate the risks by conducting a proper risk management approach in crypto trading with the help of well-regulated cryptocurrency brokerage firm ABinvesting. Read our ABinvesting Review.
Nonetheless, it is your obligation as a trader to manage the inherent risk associated with cryptocurrency trading and investing. At the same time, these risk management techniques may aid in the start-up of your trading career and the formulation of a superior trading strategy.
