Crypto Trading Risk Management

While crypto can be a lucrative market to trade, risk management is crucial. This means entering risk-averse positions, ensuring you’re never too exposed to a sudden market downturn.

In this guide, we’ll discuss crypto trading risk management strategies that all traders should know. Read on to discover how risk management can make you a more profitable trader in the long run.

Understanding Broader Crypto Trading Risks

Before delving into specific risk management strategies, we’ll explore broader risks within the crypto industry.

Read on to discover the most pressing crypto trading risks of 2024: 

Market Volatility

Most trading markets face volatility, be it stocks, indices, or forex. However, as an emerging marketplace, crypto is considerably more volatile than traditional assets. Volatility levels will vary depending on the market capitalization of each crypto. 

For example, Bitcoin and Ethereum are the least volatile. They carry mega-cap valuations, attract huge trading volumes, and have solidified their position at the two leading blockchains. In contrast, there are also thousands of micro-cap cryptocurrencies. 

These can increase in value by several hundred percent in just one day of trading. Equally, micro-cap cryptocurrencies can also become worthless overnight. Nonetheless, crypto is volatile because the market often relies on speculation – rather than anything tangible. 

For example, there are many meme coins without use cases that have increased by thousands of percent – sometimes in a matter of days. One of the most recent examples was Pepe, which produced 17,000% growth in just over two weeks. 

As a risk-averse crypto trader, you shouldn’t be afraid of volatility. On the contrary, volatile market conditions ensure that there are always trading opportunities. As long as you know how to reduce your risk, you can turn pricing volatility into consistent gains.  

Liquidity Risks

Another area of crypto trading risk management is liquidity. In simple terms, liquidity is the amount of capital that flows through a particular marketplace. The more liquidity, the easier it is to enter and exit the market. 

Established trading markets, such as gold, blue-chip stocks, and major forex pairs benefit from premium liquidity levels.

• This is also the case with leading cryptocurrencies like Bitcoin and Ethereum. 
• Over the prior 24 hours, these cryptocurrencies have attracted more than $58 billion worth of trading volume.
• However, less popular cryptocurrencies are significantly less liquid.
• New cryptocurrencies, for instance, might only generate several hundred thousand dollars in daily volume.
• This is a huge risk for crypto traders, as weak liquidity results in increased volatility.
• It can also make it challenging to exit the market at a favorable price.

After all, the only way to sell cryptocurrencies is if someone is willing to buy them. When there isn’t enough liquidity, you might be forced to accept a lower price point.  

Counterparty Risks

Crypto traders should also consider counterparty risks. In particular, the exchange or broker you’re using to trade cryptocurrencies. 

• For example, consider the FTX bankruptcy in 2022. 
• At the time, FTX was one of the largest crypto exchanges for trading volume. 
• The bankruptcy revealed that billions of dollars worth of customer funds were ‘misplaced’. 
• Had you been using FTX to trade crypto, this means your capital would have been unrecoverable. 

Therefore, crypto traders should choose wisely when selecting a platform. It’s best to opt for regulated trading platforms with robust security features. 

Best Crypto Trading Strategies for Managing Risks

We’ll now discuss the most effective crypto trading risk management strategies. This will arm you with the required knowledge to trade crypto with best practices in mind. 

Bankroll Management

Bankroll management should be implemented by all traders. Not just crypto traders but all financial markets. In simple terms, bankroll management ensures your trading capital is protected. 

Put otherwise, you’ll avoid blowing through your bankroll – even if you enter a prolonged losing run. This is because trading stakes are based on a percentage rather than a fixed dollar amount. 

• For example, suppose you opt for a bankroll management percentage of 1%. 
• You deposit $2,000 into a crypto exchange. 
• As per your bankroll management strategy, your maximum trade size is $20 (1% of $2,000). 

Suppose you’ve placed some losing trades and your balance is now $1,500. This means your maximum trade size has been reduced to $15 (1% of $1,500). With the trade size reduced, your balance is being protected. 

Conversely, let’s say you’ve been on a prolonged winning run. Your trading balance is now $4,000. This means your maximum stake size has increased to $40 (1% of $4,000). Therefore, as you become a more successful trader, bankroll management enables you to increase your stakes. 

Use Cold Storage 

The best crypto trading platforms are centralized. This means you need to trust that the platform will keep your trading capital safe. Even with the most robust security controls, this can never be guaranteed. 

Billions of dollars worth of crypto have been stolen from exchanges over time, so traders should protect their capital accordingly. The best risk management strategy here is to reduce your exposure to counterparty risks. 

This means only keeping a small percentage of your trading capital on a centralized platform. The balance should be kept in cold storage. 

• For example, suppose you’ve got $5,000 worth of USDT to trade with. 
• Consider keeping no more than 10% or $500 on a trading platform. 
• The remaining 90% or $4,500 could be kept in a hardware wallet like Trezor or Ledger. 

Linking back to bankroll management, a starting balance of $5,000 would only allow a maximum trade size of $50 (1% of $5,000) anyway. 

If things don’t go to plan and you blow through the $500 account balance, you can then transfer some more funds from your cold wallet. While not as convenient as a mobile or browser-based wallet, transferring crypto from a cold wallet shouldn’t take more than a few minutes. 

Ultimately, if the worst happens and the platform is hacked, you’re only risking 10% of your overall capital. 

Understanding Commissions and Spreads

Depending on your crypto trading strategy, you might be targeting small profit margins. This will be the case if you’re scalping or intraday trading. After all, you’ll be looking to profit from small price changes throughout the day. 

With this in mind, it’s crucial to have a clear understanding of what trading fees you’re paying. Otherwise, you could end up making a loss, even if you closed the position at a profit. There are two trading fees in particular to be aware of. 

First, you’ve got the trading commission. This is charged as a percentage of your overall trade size. 

• For example, suppose you’re paying a commission of 0.3%. 
• Your trading position is worth $500. This means you’ve paid a $1.50 commission to enter the market. 
• You close the trade when it’s worth $550. This means you’ve paid a $1.65 commission to exit the position. 
• In total, you’ve paid $3.15 in trading commissions, which will eat into your profit margin.  

Second, it’s important to understand what spreads you’re paying. The spread is the difference between the buy and sell price for the crypto pair you’re trading. 

• For example, suppose you’re trading BTC/USD.
• As per your chosen exchange, the buy price on BTC/USD is $49,250.
• Conversely, the sell price on BTC/USD is $50,750.
• This means you’re paying a market spread of 1.5%.
• So, when you enter a position, you need it to increase by 1.5% just to break even. 

Ultimately, understanding fees is a cornerstone of crypto trading risk management. This will enable you to plan accordingly, especially when setting up trading orders.  

Have a Clear Trading Strategy

Trading crypto without a clear strategy can be disastrous. You’ll end up placing irrational trades based on emotions rather than logical analysis. In contrast, sticking to a strategy aligns with disciplined risk management practices. 

There are many different types of crypto trading strategies. Choose one based on your trading experience and goals. 

For example, scalping is a short-term trading strategy that ‘scalps’ small price movements. Scalping trades might only remain open for a few minutes or even seconds. This means targeting tiny but frequent profits. With this in mind, scalping requires you to be glued to your trading chart constantly. 

Another short-term strategy is crypto day trading. Similar to scalping, you’ll aim to profit from small price movements throughout the day. However, trades remain in place for longer – often a few hours. Crucially, day trading positions should never remain open overnight. Day trading requires your full-time attention, as you’ll need to constantly analyze pricing charts. 

A slightly more hands-off strategy is swing trading. This strategy allows crypto traders to keep their positions open for several days or weeks. The objective is to follow extended trends. This means you’ll be taking on more risk to secure higher gains. When a trend reversal appears to be approaching, you’ll want to adjust your trading position accordingly.

If you’re a complete beginner, you might consider a longer-term approach to crypto trading. This means becoming a long-term investor – holding your positions for several months or years. You can also deploy a dollar-cost averaging strategy. This means adding small amounts to your long-term positions over time. 

Whatever strategy you opt for – make sure you stick to it. 

Start With Large-Cap Trading Pairs

There are thousands of cryptocurrencies in the market. The vast majority have small valuations, meaning they struggle to attract sufficient liquidity. This results in wild volatility swings, meaning you could lose a lot of money from a single trade. 

As a beginner, this doesn’t sit well with crypto trading risk management. If you’re just starting out, it’s best to focus on large-cap trading pairs. In doing so, you’ll never have any issues entering and exiting the market at a favorable price. 

For instance, more than $2.3 billion worth of Solana has been traded in the prior 24 hours. Suppose you’re looking to close a $10,000 SOL/USDT trade. This will have virtually no impact on Solana’s price, meaning you can close the position with ease. 

• Now consider a lesser-known crypto called Akita Inu.
• Over the prior 24 hours, just $280,000 worth of AKITA/USDT has been traded.
• In this instance, closing a $10,000 position could be problematic.
• This is because a $10,000 sale could have a larger impact on AKITA/USDT’s value.
• As such, you might need to accept an unfavorable price to close the trade. 

Large-cap cryptocurrencies are a lot less volatile too. For example, while Bitcoin can still rise or fall by over 10% in a trading day, this is increasingly becoming less common. Micro-cap cryptocurrencies, on the other hand, often witness parabolic pricing swings. 

While they could rise by 500% in one day, they could also decline by 99% over the same period. With this in mind, focus on large caps until you get more comfortable with the crypto markets. 

Stop-Loss Orders

Stop-loss orders sit at the heart of crypto trading risk management. Put simply, this is a trading order that protects you from losing too much on a single trade. After all, even if you’re a successful crypto trader, it’s not possible to win 100% of all positions.  

Therefore, it’s important that losing trades are capped to a certain percentage. This is where stop-loss orders come in. Depending on your appetite for risk, you might set your stop-loss position at 1%. 

So, if one of your crypto trades declines in value by 1%, it will be closed automatically. This allows you to trade risk adversely without needing to constantly watch over the markets. Simply provide the stop-loss price to your trading platform and they’ll do the rest. 

Without a stop-loss order, you could lose significant amounts. This is especially the case in the crypto trading industry, where prices can rise or fall sharply. 

All that being said, stop-loss orders are never guaranteed. If the markets move considerably and there isn’t enough liquidity, your stop-loss order might not be honored at your stated price point. This means you could still lose more than you had anticipated. 

This shouldn’t be an issue when trading large-cap pairs like BTC/USD. However, there’s a greater probability of a stop-loss order failing when trading illiquid markets.   

Take-Profit Orders

Take-profit orders are also an important part of crypto trading risk management. They ensure you enter trading positions with a clear objective. This is because take-profit orders close a position when the target price has been triggered. 

This happens automatically, meaning you don’t need to keep watching over the markets. After all, your profit target might have been triggered when you were away from your device. In this instance, you would have missed the chance to close the trade at a profit. 

The fundamentals of take-profit orders are similar to stop-loss orders. You’ll need to set a target price based on your analysis. 

• For instance, let’s say you’re trading ETH/USD, which is currently priced at $3,000. 
• You’ve entered a sell order, meaning you believe ETH/USD will decline in value. 
• You want to target 4% gains on this trade. 
• 4% of the $3,000 entry price is $120. This means your take-profit order should be set at $2,880. 
• If ETH/USD declines to this price, your trade will be closed and your 4% gains are locked in. 

Having both stop-loss and take-profit orders in place is not only risk-averse but also efficient. This is because once you’ve entered the market, you won’t need to monitor the position. 

On the contrary, the position will automatically close when either the stop-loss or take-profit prices are triggered. This allows you to free up time and focus on other crypto trading opportunities. 

Become an Expert in Specific Pairs

We’ve established that there are thousands of cryptocurrencies in the market. This number is amplified when you factor in individual trading pairs. 

For example, Bitcoin can be traded against fiat currencies like the US dollar (BTC/USD), euro (BTC/EUR), or the British pound (BTC/GBP). It can also be traded against other cryptocurrencies, such as Ethereum  (ETH/BTC) and Litecoin (LTC/BTC). 

To give yourself the best chance possible of becoming a successful crypto trader, it’s wise to focus on specific pairs. This will allow you to become an expert in your chosen pair, rather than a Jack of all trades. 

For instance, suppose you decide to focus all of your efforts on SOL/USDT. You’ll understand everything there is to know about pricing swings, volatility, core trading hours, support and resistance levels, and other technical insights. 

Always be Aware of Key Market Developments 

As a crypto trader, you’ll need to have a firm grasp of technical analysis. Equally as important are the fundamentals. This is because a key market development can have a major impact on the value of cryptocurrencies. This could impact an individual crypto or the broader market. 

For example, suppose a major economy announces that it will ban all forms of crypto trading. This could result in a sudden market downturn for all cryptocurrencies. You’d want to know about this as soon as the announcement is made. 

In doing so, you can enter a trade accordingly. The best way to ensure you’re always aware of market developments is to regularly check the news. You might even sign up for a news alert service, meaning you’ll be notified immediately.    

Learn Your Craft With Risk-Free Funds

One of the biggest crypto trading risks is that you end up losing money. This is an unfortunate reality for many beginners. Even with a bankroll management strategy in place, there’s no guarantee that you’ll avoid substantial financial losses. 

• With this in mind, starting with a demo account is an effective crypto trading risk management strategy.
• You’ll find that many crypto trading platforms offer free demo accounts.
• They usually mirror live market conditions, meaning the same price movements.
• The only difference is that you’ll be trading with demo funds.

This means you can practice trade without risking any money. You can also get to grips with bankroll management, stop-loss and take-profit orders, and other risk mitigation strategies.

Over time, you should find that you become a more competent trader. You can trade with demo funds until you’re comfortable risking your account balance. 

Backtesting

Backtesting is also an important part of risk management in crypto trading. This will help you understand how your trading strategy would have performed in historical market conditions. The best thing about backtesting is it often takes minutes to complete. 

This is the case even if you’re backtesting several years’ worth of market data. After each backtesting procedure, you can make necessary adjustments to your strategy. You can keep repeating this process until you’re comfortable that the strategy is watertight.   

Initially Avoid Leverage 

Depending on your crypto trading strategy, leverage can be an invaluable tool. This is especially the case if you’re adopting a short-term strategy like scalping or day trading. After all, you’ll be targeting small profit margins. Without leverage, these small margins might not be worthwhile. 

However, leverage is also a risky trading tool. While leverage amplifies profits, it does the same for losses. Therefore, as a newbie trader, we’d suggest avoiding leverage until you’re fully aware of the risks. 

Utilize Hedging Strategies 

Hedging is a common strategy used in all trading markets. It enables you to protect trading positions from a sudden market downturn. In the context of crypto trading risk management, hedging couldn’t be more important. 

For instance, let’s say you have an outstanding position on ETH/USD. Within the next few days, the SEC is expected to make a decision on Ethereum ETF applications. 

• If Ethereum ETFs are approved, the value of ETH/USD is expected to rise. 
• And visa versa if the Ethereum ETFs are rejected. 

As a risk-averse crypto trader, the effects of market uncertainty should be minimized. This is where hedging comes in. 

Sticking with the same example, hedging enables you to protect your ETH/USD position regardless of the SEC’s decision. 

• For example, let’s say that you’re currently long on ETH/USD. 
• You could purchase ETH/USD put options. 
• So, if the Ethereum ETF is approved, your original ETH/USD long position will likely increase in value. 
• Conversely, your ETH/USD put options will decline in value. 
• This counters the price movements out, meaning you’ve neither gained nor lost on the SEC’s decision. 

There are many different ways to hedge in the crypto market. In addition to options, you can also purchase futures. You can also hedge by opening contrasting pairs. For example, if you’re long on BTC/USD, you could also open a short position on BTC/USD. 

Keep a Crypto Trading Record

Keeping records of your crypto trading activities is crucial. Otherwise, you won’t know whether or not your current strategy is working. At a minimum, this should include the entry, stop-loss, and take-profit levels, and how the trade played out. 

However, we’d also suggest keeping a log of your trading emotions. For instance, why did you decide to go long or short on that particular trade? And why did you opt for the specific stop-loss and take-profit prices?

Keeping tabs on your emotions can help you perfect risk management in crypto trading. 

Risk Management in Crypto Trading – Final Thoughts 

In summary, crypto trading risk management is an important process for all traders – especially if you’re a beginner. This ensures that you’re trading crypto with best practices in mind. 

If you want to reduce the risk management learning curve from months to minutes, consider Algobot. 

In doing so, you can connect Algobot to your preferred trading platform, allowing the underlying algorithm to buy and sell crypto on your behalf. 

FAQs

How do you manage risk when trading cryptocurrency?

Some of the most effective crypto trading risk management strategies include diversification, stop-loss orders, backtesting, and focusing on liquid pairs. Bankroll management is also important, ensuring you avoid blowing through your trading capital. 

What are some of the crypto trading risks?

Some of the broader crypto trading risks include increased volatility, weak liquidity levels, and regulatory developments. Counterparty risks should also be considered, especially when using centralized exchanges.  

How much should you risk per trade crypto?

The 1:3 risk-reward is a good starting point for beginners. This means you’ll be risking 1% of your stake to make 3% gains.