Bitcoin is one of the most lucrative trading assets today, outperforming almost all asset classes in the past year. It is now an asset class on its own, attracting investors from all economic sectors worldwide. However, cryptocurrencies are also highly volatile financial instruments, with risks that could squash your investment dreams in a whirlwind.
Bitcoin trading usually bears several risks, including credit risk, legal risk, liquidity risk, market risk, and operational risk, all of which could impact profitability for traders. That is why you need a few risk management strategies before you start trading Bitcoin. Here are practical risk management tips to enable you to make the most of Bitcoin trading.
Position sizing refers to the number of cryptocurrency tokens that a trader is willing to buy. The probability of making huge profits in Bitcoin trading usually tempts traders to purchase 30%, 50%, or even 100% of their trading capital. However, that is a disruptive move that can expose you to serious financial risks. The golden rule is never to place all your eggs in one basket.
One of the best approaches to achieving position sizing is considering the entered amount v risk amount. The entered amount is the money you are willing to invest in every single trade.
The risk amount is the money you stand to lose if the trading does not go your way. Experts advise you should always try to limit every position to 2% risk.
Bitcoin trading is like a piranha attack, taking small bits of their victims until they consume the whole chunk. As such, you should limit the trading session to 6% per trade to avoid falling into the trap of piranhas. That would result in not more than three open positions per 2%. Limiting results in reverse compounding ensures that your losses gradually decrease with every Loss made.
Bitcoin traders can also achieve position sizing through the Kelly Criterion, which recommends you not risk more than 19% of the entire $5,000 capital to attain the best possible results in a series of trades.
Stop Loss + Take Profit.
Stops Loss is an executable order, closing an open position when the price decreases to a specific limit. Take Profit refers to an executable order, liquidating available orders when the price increases to a particular level. Both approaches can help you to manage risks in Bitcoin trading. Stop Loss allows you to avoid trades on unprofitable deals, as Take Profit enables you to withdraw from the transaction before the market gets bad.
You can rely on Trailing Stop Losses and Take Profits that automatically follow the changes in exchange rates. That feature is available in reputable Bitcoin exchanges like british bitcoin profit, equipped with various strategies to enable traders to make money from small price movements.
Risk/ Reward Ratio
The risk/reward ratio compares the actual risk level against the potential profits. One thing about Bitcoin trading is that riskier positions usually tend to be more profitable. Therefore, understanding the risk/reward ratio allows traders to know when to enter a trade and unprofitable positions.
The risk/reward ratio equals Target Price minus Entry Price, divided by Entry Price minus Stop Loss. Take for instance, $11,500 Entry Price, $10,500 Stop Loss and $13,000 Target Price.
Risk/Reward Ratio = (13,000 - 11,500) / (11,500 – 10,500) = 1.5 or 1:1.5
A 1:1.5 risk/reward ratio is the best but, you should never trade with a ratio lower than 1:1.
Like in other aspects of life outside Bitcoin trading, risks can easily discourage you from making moves. However, observing the above strategies and focusing on the potential wins will help you develop a positive attitude and significantly cut your losses in Bitcoin trading.