The cryptocurrency market is highly volatile and speculative, which means that even experienced traders can incur losses. Without proper risk management strategies in place, a trader can quickly deplete their budget and be forced to exit the market. Therefore, the primary objective of risk management is to ensure that the trader can remain in the market for as long as possible, giving them the opportunity to recover from losses. Effective risk management involves knowing when to take losses, how to manage risks, and striving to make more profitable trades than unprofitable ones.
Important Things to Consider Before Trading
Before beginning to trade, it is crucial to consider a few important factors. The first step is to determine a trader's total budget, which should be an amount of money that is freely available and not emotionally attached to the trader. It is not advisable to use loaned money or retirement savings for trading purposes.
Once a budget has been set, traders should look for potential trades using fundamental, sentiment, or technical analysis. Before entering a trade, it is important to determine the risk size, entry price, and stop loss. A general rule for new traders is to risk no more than 1% of their budget per trade.
The entry price can either be the current market price or a limit set for an order. It is also essential to decide on a stop loss before entering a trade. Technical analysis can be used to determine the stop loss by examining support and resistance levels or trendlines.
Having these four ingredients, namely the budget, risk size, entry price, and stop loss, will make it easier to manage risks while trading.
Stop Loss Orders
Stop loss orders are a crucial tool for managing risk in trading. Traders can use a stop loss to automatically close losing trades and avoid substantial losses during sudden market changes. For example, if a hacking incident causes a significant price movement in the opposite direction of a trader's open trades, a sell stop order can automatically prevent them from losing all their invested funds. Therefore, traders should always place a sell stop order to avoid significant losses.
On the other hand, a buy stop order can be used to buy an asset when it reaches a target price. This order can be helpful for automatically entering trades at target entry points.
Adhere to the Trading Plan
A trading strategy can only be successful if the trader follows it consistently, regardless of market conditions.
Successful trading relies on statistical probabilities, and thus, it's crucial to maintain discipline for consistent and profitable trading results.
However, the strategy a trader chooses should be tailored to their specific goals, risk tolerance, and lifestyle. It should be grounded in reality and not based on wishful thinking.
Copying another trader's strategy without fully comprehending it can lead to incompatibility issues and difficulty adhering to the strategy.
Ultimately, every trader is responsible for their own trading decisions and should exercise caution when selecting a trading strategy and evaluating market opportunities.
Emotional trading should be avoided
There are two primary emotions that can sway a trader from their trading strategy: fear and greed. These emotions are responsible for FOMO or the fear of missing out. FOMO occurs when a trader fears missing a lucrative trading opportunity and thus is likely to deviate from their strategy to pursue it.
Greed can prompt traders to purchase assets at high prices, fearing a loss of potential profits, while fear can lead them to sell at low prices, fearing further losses. When hype rather than careful research and strategy guides trading decisions, fear and greed are amplified.
To avoid making emotional trading mistakes, traders must control their emotions, avoid taking unnecessary risks due to FOMO, and refrain from engaging in revenge trading, which involves attempting to recover from a loss by making impulsive trades. Revenge trading can lead to overexposure in a single asset, which can be considered gambling and has both logistical and psychological consequences.
It is generally advised to invest and trade in cryptocurrency with a small portion of the total capital allocated for this purpose. This advice is based on two key concepts: risk/reward and statistics.
From a statistical standpoint, larger bid sizes carry a higher potential for risk and reward per position. While the potential rewards may be attractive, it is crucial to limit risk in order to ensure long-term success.
In reality, statistically speaking, the risks associated with large bid sizes relative to the total budget tend to outweigh potential rewards over time, on average.