Risk Management for Crypto Trading

Risk Management is an Important Part of Trading Crypto

Trading cryptocurrency is inherently risk. To succeed in the long term, you will need to manage that risk. If not, then you risk turning from trader to gambler and slowly losing your account to bad trades. 

Take the fact that in losses are more impactful than gains. If you make a 10% gain and a 10% loss, you do not break even but lose money. For any % loss, it takes a larger % gain to break even. Check out our calculator and you can see for yourself. 

Another fact is that all trades will make losing trades. The trick it is manage that risk, and only enter into trades that you can tolerate. 

Risk:Reward - A Constant Calculation

As in all things in life, there is a need to consider the risk of any activity with the reward. Would you risk losing 1 Bitcoin to gain 1 Bitcoin? What about risking .02 Bitcoin to gain 1 Bitcoin? This is the basic essence of risk management. 

The second half of this ratio it the accuracy of your trading. While it is always better to have a high accuracy in making the correct plays, having a better Risk:Reward ratio gives you leeway in how you trade. 

Consider this: if you have a Risk:Reward ratio of 1:1, you’ll need to be right more than 50% of the time to make money in the long term. However, if you have a Risk:Reward ratio of 1:10, you only need to be right more than 9.1% of the time. 

Check out our calculator and see what different levels of Risk:Reward do in terms of accuracy in trading. 

Calculating your Risk:Reward level is fairly straightforward. Your Risk is the difference between where you entered the market and your stop, and your Reward is the difference between your target and where you entered the market. However, we made a calculator to help you with your trades. This finds both your Risk:Reward ratio and the accuracy you need to have in the long term to make money. 

 

Limiting Risk by Limiting Loss

Another easy way to limit the amount of risk in your trades is to limit the amount of losses that you could possibly take. This can be done in several ways such as the 1% Rule or dealing with Piranhas and sharks. 

The 1% Rule

Many professionals will tell you to limit your trades to only 1% of your trading account. Their logic is sound: if you loose 100% of your trade, you have only lost 1% of your account, and can come back from that. There are a couple different theories on how to do this. One is to trade with only 1% of your account, the other is to set your stop to be 1% of your account. 

For Example, say that you have $100 in your trading account. You can limit your losses to 1% of your account by only trading with $1. This way, if you lose your $1, you have lost only 1% of your account. 

Alternatively, you could trade with your entire account, but set your stop such that you can lose at most $1. For instance, if you by $100 of Bitcoin at $10,000, then you should step your stop at $9,900. If you only use $50 to trade (half of your account), you can now set your stop to be at $9,800, or 2%. 

Using these rules also depends on your risk tolerance. If you only have $100 in your account, maybe you are comfortable risking 5%, or even 10% in a trade. after all, this amount of funds is easy to replace. However, when your account reaches a value of $100,000, using positions based on 1% of your account may make more sense. Especially considering that larger positions need more liquidity in the market to cause less slippage when traded. 

Piranhas and Sharks - Limiting Risk by Limiting Loss

Your risk management can also include provisions based on your account health. If you don’t trade, you cannot lose money, and maybe if you are going on a losing streak, it is worth taking a break. This is where the concept of piranhas and sharks come into play. 

A shark will eat you in one bite, but piranhas take many nibbles. Many 1% losses are just as bad as a 20% hit to your account. As such, you could build a emergency stop into your risk management plan by suspending your trading activity if either you take a single 10% hit, or 3 1% hits in a row. 

As shown above, losses take more out of an account than gains, and if you use something to a 1% rule, each loss limiting your trading position which can limit gains. If you let your account take losses without recovering, you could find yourself working uphill to reach break even rather quickly. 

As such, it might be worth considering that if you are running on a losing streak, to take the rest of the month off. Maybe paper trade a bit instead of actual trading. Work on your technical analysis or research the fundamentals of your coin. 

Risk Management Summary

Your account health is paramount to your long term success in trading, and managing the risk you put your account in is paramount to its health. Managing risk can be done either by taking trades with a good Risk:Reward ratio, by trading with only a subsection of your account, or limiting any loss based on the size of your account. Also establishing firewals incase of a series of bad trades can help prevent losing streaks that are detrimental to account health. 

Overall, however, whichever plans you incorporate are only as good as your ability to follow through. As with your trading plan, your risk management requires a large amount of discipline to make happen.