Risk management is the process of identifying potential risks and mitigating them to maximize returns. It is the core of all types of trading and investments. Indeed, in the past, we have seen excellent traders and investors lose money for not efficiently managing their risks. In this article, we will look at some of the best risk management strategies to use when day trading cryptocurrencies.
Using a quality crypto broker
The simplest risk management strategy is to use a good broker. This is because, in the past, thousands of people have lost cryptocurrencies worth billions of dollars simply because they used the wrong broker. For example, in late 2018, investors lost crypto worth more than $120 million when a Canadian exchange owner died. He was the only person with the passwords to access the digital assets.
Ideally, you can trade cryptocurrencies using two main types of brokers. First, most cryptocurrency exchanges like Binance, CEX, Gemini, and Coinbase have a feature that allows people to trade crypto using margin. Second, you can use a traditional broker like Interactive Brokers, Robinhood, and eToro.
To manage your risk, we recommend that you use a reputable company that has millions of users and the financial capability to afford the best security features. For example, companies like Robinhood and Coinbase are multibillion-dollar companies that have the most advanced security features to avoid breaches.
Another option is to use online forex brokers that offer cryptocurrency CFDs. Some of the brokers we recommend are companies like easyMarkets, FxPro, OctaFX, and Capital.com.
In short, before you open a crypto trading account, read more about the broker you want to use. Use online reviews and social media to find the experience of past clients.
Binance crypto trading platform
Be careful about leverage
To most people, it is almost impossible to day trade cryptocurrencies without leverage. For one, with the price of Bitcoin at more than $16,000, most ordinary traders cannot afford it. Fortunately, most crypto brokers offer leverage, which is an important tool that increases your buying power.
For starters, leverage is similar to a loan. For example, if you have $2,000 in your account and you select to have a 1:100 leverage, it means that your buying power is $200,000. That means you can even trade Bitcoin and other cryptocurrencies. To use this leverage, you will need to offer the broker collateral, which is known as margin.
Leverage can help you make more money. For example, as of this writing, one ETH is trading at $450. If you used your $2,000, you would buy just 4.4 ETHs. Therefore, if the price rallied to $500, your profit would be just $222. On the other hand, with the 1:200 leverage, your profit would be about $22,000.
However, leverage is a double-edged sword. While it can make you a lot of money, it can also cost you a fortune if your trades go wrong. Therefore, we recommend that you start with small leverage and increase it as you become a better trader.
Always use a stop loss
A stop loss is a risk management tool that is offered by most traditional and modern cryptocurrency trading companies. The tool automatically stops your trade when it reaches a certain level that you set yourself. For example, if you have the $2,000 we have mentioned above, you can plan not to risk more than 10% of your funds per trade. This means that the maximum loss you are willing to lose per trade is $200.
Therefore, if a trade goes against you, it will be stopped immediately when you lose $200. Therefore, you will not be affected when the cryptocurrency continues moving against you.
While a stop loss is good, the trailing stop loss is even better. Unlike a stop loss, which is fixed, the trailing stop loss is usually dynamic, meaning that it moves with the price.
For example, think of this trade. You buy ETH at $450 with a profit target of $470. Also, you put a stop loss at $440. In this case, if the price rises to $467 and then reverses to $440, your initial profit will be erased, and you will make a loss. With a trailing stop loss, your initial profit will be protected.
A stop loss should be used together with a take profit. A take profit is similar to a stop loss, with the only difference being that it stops a trade immediately after it hits your preferred profit level.
Position sizing refers to the number of cryptocurrencies you are buying or shorting per trade. Like leverage, we have seen many successful day traders lose money because of the failure to position their trades well.
The most important rule is that you should not risk trading with money you cannot afford to lose. If you have a $20,000 account, you should avoid spending it all on a single trade. Instead, you should have a risk management strategy that ensures that you don’t lose a small amount of the funds. For most traders, this limit is usually 3%. As such, you should open relatively small trades that ensure you protect your account.
To be clear, opening small trades will reduce the amount of profit you make per trade. However, it also exposes you to smaller losses, which is a good risk management strategy to use.
Finally, another simple risk management approach is to avoid the temptation of overtrading. This is because you expose yourself to more risk when you open tens of trades per day. Also, you spend more money in commissions when you open these trades.
Instead, your crypto trading strategy should revolve around opening a few trades that are well-thought every day. Doing this will help you maximise your profits while minimising risks. This point goes with the need of having a good trading strategy and sticking with it as a day trader. Some of the strategies you can use are swing trading, algorithmic trading, and even pairs trading.
Having excellent day trading skills is not enough. In fact, we have seen talented traders lose tons of money in the cryptocurrencies market. The ideal combination to have is having a good trading strategy, an understanding of the crypto market, and risk management. Using the five approaches we have mentioned here can help you become a better trader.