Risk management is one of the most important elements to successful trading. No matter how good you think your trade set up is, nothing is ever guaranteed. Every trader takes a hit from time to time but having an effective risk management strategy is what will keep you in the game for the long haul, especially when trading bitcoin.
Here are five ways you can reduce your risk exposure when trading bitcoin:
#1: Protect yourself from Counterparty Risk
Although the cryptocurrency markets have some of the highest percentage gains, they still have their problems and exchanges come with a degree of counterparty risk. Bitcoin transactions are irreversible and trusting an exchange with your private keys can be disastrous. There’s a long list of crypto exchanges getting hacked and losing money.
As crypto traders we can’t completely eliminate counterparty risk but we can take steps to greatly reduce it.
- Don’t leave coins on an exchange when not actively trading
- Only trade with 20-30% of your portfolio
- Diversify your coins amongst several exchanges
- Research the exchange to make sure it has a solid reputation.
#2: Trade Quality over Quantity
Traders who over trade the markets tend to waste the most time and money. The key to effective trading is to choose quality over quantity. Not every type of market condition will be conducive to your strategy. Swing trading works best during strong trends, whereas automated scalping tends to be more effective when the markets are stable.
To find quality trades you must first determine what trading style works best for you, as well as identify the right market conditions.
#3: Have an Exit Strategy
Identify key support and resistance levels on the charts and map out your trades ahead of time. Determine the risk to reward ratio and set your targets for taking profits. Traders can either add to their position during strong trends or lock in profits by scaling out along the way.
You also want to make sure to set stop orders to protect yourself in case the markets move against you. Just keep in mind that stops aren’t always effective when the price moves too fast and you may get a bad fill due to slippage.
#4: Don’t use Excessive Leverage
Traders often use margin because it increases the order size and allows the flexibility of going long or short. That said, if you use too much leverage your trades won’t have enough time to breathe and you can lose your entire principle amount during forced liquidation.
There are some exchanges that offer leverage as high as x100 but a 1% move against you can destroy your account. A more sane approach to using leverage is x3. This will allow you to increase your gains while giving you enough of a buffer zone to exit a bad trade. The only exception to this rule would be scalping smaller time frames during volatile markets. The longer you hold your trade the less leverage you want to use.
#5: Avoid Hype
Fear of loss and of missing out are a trader’s worst enemies. Become too greedy and you may end up buying tops. Panic sell and you might cash out your position at the bottom of a dump. Managing emotions and being objective is half the battle.
Usually when hype is at its peak it means that the markets will reach its distribution phase and a down trend may ensue. The media is often late to the party, reporting on trends after the fact once the markets are exaggerated. Get in before the herd and sell into strength when hype is at its peak.