In general terms, risk management can be described as the process of identifying, analyzing and mitigating the uncertainties that come with making investment decisions. Anyone who wants to be a successful trader needs to have excellent risk management skill. The relevance of this skill becomes more pronounced in crypto trading due to the volatility of the crypto industry and the continuous uncertainty surrounding trading in the industry’s assets. No matter how good you think your trade set up is, it is pertinent to bear it in mind that nothing is completely guaranteed when it comes to crypto trading.
In trading, some record more successes than others because of their risk management skill which has instilled a level of discipline in them. Thus, while a lot of traders are constantly searching for quick money schemes which opens them to more risks, the successful traders carefully analyze a prospective investment before they launch in. As such, even though all traders make not-so profitable investments at different points, the risk management strategy of successful traders helps them remain in business for a longer period.
There are really no definite rules for managing risks because trading scenarios ought to be approached on a case-by-case basis. However, there are some risk management tips that can be very useful in developing your own risk management strategy. Some of these tips are:
Never Invest An Amount You Cannot Afford To Lose
This is by far the most important rule when it comes to general trading and by extension, crypto trading. Trading comes with high risk and cryptocurrencies are particularly very volatile. Do not borrow money to invest, neither should you use money meant for other important and urgent expenses. Investing in cryptocurrencies is risky but investing a sum you cannot afford to lose is riskier. Anything can happen at anytime and to protect your position, put a limit on your level of investment
Carry out your own research
The advantages of undertaking your own research cannot be overemphasized. Doing your research ensures that you have a first-hand understanding of the company you are looking to invest in. Although there are experts who serve that purpose, it still doesn’t preclude you from carrying out your own research.
Thus, visit the website of the company and peruse their whitepaper so you can make informed decisions. This way, you are not just guessing, but you are with adequate details to influence whatever trading decision you will eventually make. It is also at this stage that you get to gather sufficient knowledge about a particular exchange and how solid the exchange is. Personal research also helps you remove emotions out of your trading and makes you maintain objectivity.
Prioritize Quality over Quantity
So many traders who over-trade the markets usually end up wasting both time and resources. At the end, their desire for quantity over quality always makes it difficult for them to identify potential risks in certain crypto assets. One key factor that helps effective trading and reduces risk is prioritizing quality over quantity.
In addition to prioritizing quality, you also need to analyze the market conditions. This is because the strategy suitable for adoption sometimes vary depending on the market conditions. For example, while swing trading is suitable when there are evidently strong trends, automated scalping is deemed more effective in stable markets.
Diversify as much as possible
Another important tip to managing risk is to diversify. Flowing from this is to also consider the size of your portfolio. If you keep the need to diversify at the back of your mind while trading, you will never go all in regardless of how promising a coin seems to be or how lofty the team’s ideas are. By diversifying, the high volatility of virtual currencies wouldn’t have excessive effects on you should anything go wrong.
It is advisable to spread your investment in a minimum of 10 coins so as to have a secured and balanced portfolio. Diversifying does not automatically mean you should invest in hundreds of coins. Invest in the number that you can easily track with no stress.
Try to protect yourself from counterparty risk
Even though the cryptocurrency market has high percentage gains, the market has several problems one of which is the high level of counterparty risk. It is settled that coin transactions are irreversible. Thus, putting all your trust in an exchange can be a disaster if the exchange is hacked.
Different exchanges have been in the news of late because they were hacked and several people lost a whole lot of money. As a crypto trader, there is little you can do to eliminate counterparty risks, but you can reduce the effect such would likely have on you. As such, avoid leaving your coins when you are not in active trading at a given point. Also, it is advised that you keep trading between 20-30% of your total portfolio.
Attach little importance to media hype
The biggest enemies of a trader are the fear of missing out (FOMO) and the fear of recording losses. If on the one hand, you are a greedy trader, then you may invest heavily in a bad asset. On the other hand if you panic sell, then you might end up losing a whole lot. Therefore, you should be able to maintain objectivity while also managing your emotions so as to effectively reduce such risks.
Studies indicate that the periods when hype is at its peak are periods when the market has gotten to distribution phase. What would likely occur after will be a downtrend. In essence, the media often reports trend when markets have become exaggerated. Thus, try to get in the market before the hype and sell on the strength of the market hype.
Create an exit strategy
Having sufficient knowledge about the core support and resistance chart levels is very essential to protecting your position as a trader. This knowledge would make it easy for you to plan your trades prior to time. It also helps you decide the ratio of the risk to reward at any given point and also set reasonable profit targets. You also need to have specific stop orders that will help you protect your position just in case the market turns out to be unfavorable. However, stop orders do not particularly guarantee anything, they are just to help you remain on the positive side of the markets.
In conclusion, cryptocurrencies are extremely volatile and you need to be smart about your trading so you do not make wrong trading decisions.