While cryptocurrencies are now considered to be a good addition to a well-balanced portfolio, it still stands that this asset class comes with its own set of risks. Before you exchange your fiat money for crypto coins like Monero and store them in your free XMR wallet, you need to have a clear idea of what the risks are and what your cryptocurrency risk management strategy will be. Doing your due diligence for a potential investment, after all, is part of being a responsible investor.
What Are the Risks That Come With Investing In Cryptocurrencies?
There are several types of risks that you should watch out for when investing in cryptocurrencies. There’s credit risk or the possibility of a loss due to a borrower’s failure to meet a loan or fulfill their financial obligations. This can take place when you fall victim to fraud or theft while taking part in cryptocurrency trading.
There’s legal risk or the possibility of running into issues related to rules set by regulatory bodies, and this can happen when a location bans the trading of certain currencies or if your holdings become subject to legal proceedings. The cryptocurrency market is also quite volatile, so there’s always a chance of running into market risks and liquidity risks.
Finally, decentralized currencies require a lot of agents before they can be viable, making the system subject to operational risks. Should your chosen exchange or wallet run into issues, then you might not be able to use your cryptocurrency assets.
How Can You Mitigate Risks When Dealing With Cryptocurrencies?
Just like with any other type of investment, would-be cryptocurrency holders shouldn’t risk beyond what they are comfortable losing. It’s never a good idea to trade with borrowed money, for one, as this will expose you to greater credit risk. At the same time, you shouldn’t take money out of your emergency funds, as this should be separate from your investment money. Many experts suggest dedicating around 10% of your monthly revenue or budget to crypto, especially if you’re still learning the ropes.
Besides that, you should keep in mind that cryptocurrency trading is the field where all of your basic instincts are counterintuitive, and here is when a crypto trading bot can keep your emotions under control.
At the same time, there are certain trading strategies on cryptocurrency platforms that you can implement once you’ve dipped your toes into digital currencies. These are:
Activate Stop Loss and Take Profit Functions
Stop Loss is a function that can be automatically activated if a currency’s price dips below a specific level, and it works by closing an open position. Turning on this feature will enable you to automatically avoid trades that will turn out to be unprofitable for you. Take Profit is the exact opposite. This function opens orders when prices hit a predetermined ceiling. Using this feature will enable you to make the most out of trading opportunities before the tides turn.
2. Calculate the Trade’s Risk-Reward Ratio
Taking on risks comes with rewards in trading, so it’s not out of the ordinary for less risk-averse traders to earn hefty profits now and then. If you want to maximize your profit while keeping your possible losses under control, you can compare the actual level of risk with your potential earnings before you make a trade. The formula for the risk-reward ratio is as follows: (Target Price – Entry Price) / (Entry Price – Stop Loss)
If you end up getting an answer of 1.25, for example, then you have a risk-reward ratio of 1:1.25. It’s a good idea not to take trades that are less than 1:1.
3. Think About Your Strategies for Position Sizing
Determining the right amount of tokens you should buy is the first step in mitigating your possible losses. It can be tempting to put a huge chunk of your entire trading capital in cryptocurrencies since the asset can be quite profitable from time to time, but think carefully before you make any commitments. Here are sound ways to determine how much of your capital should go into cryptocurrencies.
Enter Amount vs. Risk Amount – This considers the amount that you want to invest and the amount that you may lose should the trade fail. You can get to this number by using this formula: ((Stack size * Risk per Trade) / (Entry Price – Stop Loss)) * Entry Price
Elder’s Sharks and Piranhas – Credited to professional trader Dr. Alexander Elder, this strategy advises traders to limit their risk for every position at 2% and set their trading limit at 6% for every session. Doing the former reduces your risk of losing a significant amount, while doing the latter prevents you from spending a lot of money in small increments without noticing it.
In addition to these strategies and calculations, it also pays to have an eye for detail when choosing the best trading platform. Some cryptocurrency exchanges charge traders a fixed price, command a percent of trading profits, or change their fees according to the movement of the market. Small as these may be, the fees can add up and cut into your earnings. At the same time, don’t be too quick to dismiss exchanges with higher fees, as these platforms often offer traders useful tools for maximizing their profits.
Adding cryptocurrencies to your asset portfolio comes with risks, but it can also provide you with plenty of rewards. Play your cards right, get to know the market better, and refine your processes for making trading decisions, and there’s a good chance that your crypto investment will be worth the risks that you are taking.