Risk Management in Crypto Investing

When it comes to investing, taking risks is a part of the game. This occurs due to a lot of market factors. On top of that, if you are investing in cryptocurrencies, there is a high risk as crypto, by nature, is highly volatile. Therefore you need a proper risk management strategy to minimise your losses in case the market turns against your favour. 

Read on to learn more about managing risks in crypto investment. 

What is risk management in crypto investing?

Risk management is the process of discovering potential risks in the crypto investment and devising a strategy to handle them in the best way. 

Let’s take an example to understand why it is important. Suppose you have $1,000 and invest it all in Ethereum. Due to its inherent volatility and other market factors, the price of Ethereum falls, and you end up making a huge loss. 

This is common with new investors who have yet to learn risk management. The above example may not match in real life, but if you look at the charts of major cryptos, you can see continuous ups and downs. 

Thus, having a risk management strategy is crucial. If you are thinking of how to frame a strong management strategy, you can follow the guidelines below:

Do not put all your money on one asset

It is a common mistake that new or inexperienced investors make. They invest all their money in a single cryptocurrency. If the value of that crypto drops by 50%, that person loses half of the investment in one go. Inversely, if you diversify your investment across various crypto assets, then even if the value of one asset falls, you still have your other assets to keep you in profit. This is because the rate of volatility varies across different crypto assets.  

Avoid emotional trading

New traders tend to conduct trades based on intuition rather than logic and calculations. Experts call this phenomenon FOMO or fear of missing out. In such cases, traders invest 30 to 40% of their investment capital on one asset. This is a very risky practice since if the asset's value falls by chance, they will face a huge loss. 

Apply the 6% and 2% rule

Experts suggest starting an investment with at most 2% of your capital. Some even recommend not going over 1% while opening a position. This way, you will never totally drain out your investment capital. The 6% rule states that you should stop trading if you lose more than 6% of your capital while trading. You can take a rest for a week or two and then resume. This break will help you recover mentally and think about your trading tactics. It will also prevent rash decisions from your end that may further your losses. 

This rule is very closely related to the capital loss limit principle. It states that when you enter a position, the total risk of all orders should not exceed 25%. Following this principle will ensure you will still have 75% of your deposit even if all your trades turn out unprofitable. 

Utilising stop-loss and take-profit orders

A stop-loss order is an instruction that you give to a cryptocurrency exchange platform to sell crypto at a particular price point to limit the loss. This will reduce the chances of additional losses. 

Let’s take an example for better understanding. Suppose you bought Bitcoin assets worth $4,000. You conducted a market analysis and concluded that the price of Bitcoins will rise. 

However, considering the volatile nature of cryptocurrencies, you should implement a strategy to save your investment in case its value falls. You can issue a stop-loss order on the exchange platform that the assets should be sold if the price of BTC falls below a certain mark (say $3,700). 

Therefore, even if crypto prices fall at a heavy rate, you can minimise your losses using this strategy. Some investors like to hold their crypto assets longer just to get a high profit. This tactic may sometimes backfire as crypto being highly volatile, can rise or fall anytime. You can counter such situations via a take-profit order. This order lets you set a price at which you want to sell your crypto assets. When the price of that asset reaches that level, the exchange triggers a sale. 

Determining your reward/risk ratio

In the long run, all your trades will not be profitable. Therefore, you must determine a crypto coin's reward/risk ratio to calculate how much profit you can earn for every unit of capital you risk. Experts always suggest investing an amount that you can afford to risk. 

Researching your targeted cryptocurrency

Before investing in a certain crypto coin, conduct thorough research. You need to determine the credibility of the blockchain project that is offering the crypto coin. For example, you can read up about the team behind the project. This will give you a clear understanding of their company roadmap and goals. Based on these aspects, you can determine whether that cryptocurrency has the potential for success. Furthermore, you can look at a crypto coin’s trading history. You can observe its growth pattern and plan your investment accordingly.   

Mistakes you should avoid for a better risk management strategy

Apart from following the above guidelines, there are a few investing mistakes that you should avoid. They are:

• When you lose money after an unprofitable crypto investment, it is natural for you to desire to recoup your profit immediately. This attitude leads to more rash decisions that can increase your losses. Instead, you should record and learn from your losses and rationally decide what to do next. 
• Overconfidence can cause massive blunders when it comes to crypto trading. Sometimes, investors tend to put in 30 to 40% of their investment capital as they speculate that the price of a certain cryptocurrency will go up. This is a massive risk, as even professional forecasts cannot give you a 100% guarantee on the profitability of crypto. The best way is to have the correct risk management strategy and not invest huge amounts. 

It is common to make mistakes and incur losses while investing. However, having a sound risk management strategy will ensure minimal losses, and you do not entirely drain your capital.