Risk Management Tips for Cryptocurrency Trading: Lesson 4

Introduction

Cryptocurrency trading is an amazing new opportunity for anyone interested in financial investments. It involves strategically buying and selling crypto, a digital asset, on cryptocurrency exchange platforms. 

In previous lessons, we’ve covered

• what cryptocurrency involves, 
• how to get started in trading, 
• trading strategies, and tools. 

In this lesson, we’ll guide you through risk management tips to protect your crypto trades. Adding solid risk management procedures to your trading strategy is vital to success. In a highly volatile market, risk is a given. However, risk management will help any trader impose a level of control over the risk they take. 

Not all risk is bad - sometimes, higher risks can equal higher rewards. Having the ability to control when you subject yourself to higher risk will lead you to a more comprehensive strategy.

How to use stop-loss orders

The stop-loss order is one of the most popular and well-known risk management tools. This market order is set by the trader. It only executes when certain market conditions are met, meaning traders can customize their order according to their strategy. The stop-loss order is usually set at a price lower than what the asset was bought for. 

This allows traders to avoid losing too much money if the price continues to fall. Traders should account for short-term price fluctuations. Setting the price too high can cause the order to trigger too quickly. Most traders place a stop-loss order just below a level of support. If the price falls below this level, it’s more likely to continue falling. 

Stop-loss order example

For example, let’s say you’ve bought a unit of cryptocurrency for $500. Setting the stop-loss order at $460 is too close to its original price. However, setting it at $400 could work more effectively. Before you set your stop-loss order, you can also analyze how much loss you’re willing to tolerate. You can do so by using a risk-to-reward ratio, which weighs risk against potential profit. 

If the price falls to $400, your trade will close automatically to prevent further loss. 

How to diversify your portfolio

Diversification is a highly recommended risk management strategy, used by the vast majority of crypto experts. 

“What is portfolio diversification?”

Portfolio diversification describes simultaneous investing in a range of different assets. By doing so, traders can lower their exposure to risk from any one asset. Think of the phrase “Don’t put all your eggs in one basket.’’ 

If anything happens to that one basket, all your eggs inside might crack and become worthless. By dividing your assets into multiple baskets, you can protect your assets from volatility. This is best done by putting money into multiple established and well-known cryptocurrencies. 

You can improve the effectiveness of your diversification further by analyzing each asset’s risk. If your goal is to protect from loss as much as possible, divide your assets inversely to the risk level. 

The higher the risk of volatility, the less you invest. Some exchanges, like Walbi, will provide you with detailed market recommendations and investment suggestions. Keep your options open and use these resources to make smart trades with multiple cryptocurrencies.

Pro tip: Don't invest more than you can afford to lose

It’s a rookie mistake to ‘bet’ an amount of money on the chance you’ll get high returns. For example, buying $10,000 of Bitcoin, thinking you’ll sell it for three times as much. If losing that $10,000 means you have emptied your account (or gone into debt), you shouldn’t invest it. 

While there are many stories of cryptocurrency turning people into millionaires overnight, this is incredibly rare. Volatility can cause massive price spikes - up, or down. Plus, there are other risks when investing in crypto. While very unlikely, hacking, scams, and even exchange shutdowns can occur. Some crypto exchanges, like Walbi, already have built-in security measures to protect against these threats. Walbi’s well-protected exchange even uses AI to detect fraudulent activities and preemptively react.

Before you invest, analyze your financial situation and determine a tolerable level of loss. Some experts recommend tallying your net worth (which includes your assets, income, and more) and only investing 1-3%.

Other risk management strategies

Other than stop-loss orders and diversification, there are multiple strategies you can customize to your financial goals. One of these strategies is dollar-cost averaging or DCA. 

Suggested reading: Check out Lesson 3 for a detailed look into the DCA strategy.

In this strategy, a trader makes smaller investments in an asset at regular intervals. For example, let’s say that a beginner trader wants to invest in Bitcoin. They have set a budget of $500 for a long-term investment. 

For example, instead of pouring that $500 into one big purchase, the trader can use DCA and invest $100 once a month, for five months. Of course, you can also invest daily, weekly, or even yearly. It depends on your budget and how long you plan to hold your position. The advantage of DCA is averaging out your investment costs, and reducing the impact of short-term fluctuations.

Hedging

Hedging against risk is another strategy. Hedging has been done with all kinds of assets, and crypto is no exception. It involves buying or selling crypto to directly reduce risk for another position, or due to market movements. There are multiple ways you can hedge. DCA is one of these methods. 

Traders can also hedge using futures contracts. These contracts make bets on the future prices of crypto assets. If you invest in futures contracts, you can benefit from crypto without owning any outright. You can also own futures contracts for crypto, like Bitcoin, and own Bitcoin directly. If you suffer losses from your Bitcoin due to short-term movements, you can sell your futures contract to offset the loss. Another hedging method is leverage. 

What is leverage?

Leverage is when you borrow crypto from an exchange (or another crypto entity, like a broker) to increase your buying power. How much you’re able to borrow usually depends on the collateral in your digital wallet. Walbi allows you to leverage up to 500x your account balance! 

You can also use leveraged funds to buy futures contracts or crypto derivatives. This method is also called margin trading.  Margins are the regular payments you must make to keep your leveraged funds. With the ability to buy more, you can also sell more and gain higher profits.

Of course, leverage comes with its risks. If you’re not able to pay your margin, your broker can sell all your tokens to recover their loss. Plus, most leveraged positions are only allowed to stay open for a year. If you want to keep a long-term position open, using leverage probably won’t help.

Conclusion

Adding risk management strategies and tools to your crypto trading is crucial in protecting your assets. The tools we explored above can not only keep your funds safe but increase your potential returns! While these strategies might seem complicated, choosing the right crypto exchange can make them easy.

Walbi works hard to provide its users with advanced market analyses and liquidity management. Walbit Lighthouse, our sophisticated AI trading assistant, can guide any trader in making profitable and low-risk trades. Give it a try! But first, put your knowledge to the test.

Earn 500 XP by completing this simple task

Execute one Stop-Loss Order on the Walbi platform using knowledge from this cryptocurrency trading lesson. Click the button below to begin!