Almost any person related to the trading industry knows that cryptocurrency trading contains more risks than any other type of trading excluding unorthodox trading industries like binary options or OTC trading. To become a successful crypto trader it’s not enough to follow simple rules of risk management applied to stock trading. For the cryptocurrency industry, you would need to know more convenient ways of position derisking.
Basic risk management
Though you need to follow more complicated risk management strategies than ones that are being used in stocks trading, you still need to know the industry basics including proper risk/reward ratio, stop-losses and take profits, and backtesting.
You should always use regular or trailing stop-loss orders while opening your position. Since the cryptocurrency market is far more volatile than stock or forex markets, stop-loss is mandatory. Without using stop-losses you are risking getting under 30-40% correction that usually happens in the term of one day.
The same rule applies to the take-profit orders that you should have to catch a rapid price increase which is especially popular on the smaller cryptocurrencies known as altcoins. Due to the low liquidity, even the smallest pump can launch almost any asset’s price into the moon and you don’t want to miss it.
Risk management in crypto trading
The main difference between risk management in crypto and traditional markets is usually reflected in the position sizes. While most stock traders trade around the standard of 10-20% of your portfolio equals your trading budget, cryptocurrency traders can go as low as 2% per trade since the volatility is far greater than on the stock market.
While the average volatility on stocks remains around 3-5% per day, cryptocurrencies might face up to 20 percent daily volatility. With 4 times more risk, your position on the crypto market should be 4 times smaller than on a stock market. By taking fewer risks and keeping your risk/reward ratio close to 1.5 or 2 you’ll even be able to afford a negative trade win rate while remaining profitable.
While most stocks listed on national exchanges have no problems with liquidity for average retail traders, some cryptocurrencies might have liquidity problems. Major altcoins like Ethereum, Cardano, or Litecoin won’t have any problems with satisfying your trading need, but coins with less than $1 million of trading volume sometimes face order book congestion or large gaps on the chart.
That’s why you should risk even less while buying into assets with low liquidity. Since you won’t be able to properly utilize stop-loss or take-profit, you should change the size of your position. If your standard position size is 2% from the overall portfolio, make it 0.5% since there’s a chance of losing up to 50% of your position value.