Traders today can access vibrant, global crypto markets that run 24/7. But trading digital assets exposes them to industry-specific risks, like volatile price movement and exchange vulnerabilities. So let’s dive into what crypto trading risk management involves and discuss actionable ways you can manage risk using Quadency.
The 3 Key Elements of Risk Management
- Identifying Risks
- Define a Strategy & Stick With It
- The Right Tools to Mitigate Risk
1 - Identify the risks
Risk management simply refers to the process of limiting potential losses by creating a plan to manage potential risks. Cryptocurrency markets involve specific risks traders should be aware of in order to optimize the possible outcomes. Let’s take a look at some examples:
Single point of failure / exchange hack
You have some money earmarked for trading crypto so you open up an exchange account to get started. All is going well until a few weeks later when you receive an email from the exchange: There was a hack and all deposits and withdrawals have been halted. Your investment and any potential earnings are either gone to hackers, or locked up for an undetermined amount of time while the exchange investigates.
Fear of missing out (FOMO)
You’re new to crypto and you notice that everyone in your social media feed is talking about Dogecoin. So you decide to buy some $DOGE. In other words, you “FOMO in” by buying at peak hype and a high price because of your “fear of missing out.” The very next day early holders sell and Dogecoin’s price crashes, leaving you with a 50% loss overnight.
In the above examples, investors could have lost their original capital and profits via exchange vulnerability or extreme volatility. Below are some additional risks to watch out for:
- During bull markets with extremely heavy trading volume, exchanges may shut down temporarily due to overload. For traders, this could mean missing potential gains from large price swings.
- Liquidity risk can occur when an exchange does not have a deep enough order book to place all your trades quickly and for the best price.
- Storing your digital assets is more complex than storing cash. With the private keys to your coins, you have complete ownership but must also safely store and protect your keys. If you lose them, you lose your crypto.
Luckily, traders today have many options for managing these types of factors, so in the next section we provide some guidance for planning your risk management strategy.
2 - Plan your risk management strategy
Once the risks have been identified and measured, investors can start to plan for them.
DYOR - Do your own research
With so many crypto assets circulating today and hype in trading groups and across social media, a good strategy needs to do backed by your own research on individual assets.
Define your trading strategy & stick to it
Having a defined strategy will help you remove emotion and FOMO, while lowering your risk exposure. The first step is to determine what type of trading strategy is right for you. Some prefer various day trading strategies, while some are geared towards going long in a bull market or shorting crypto in a bear market.
Most importantly, once you define your strategy, make a plan to stick with it!
Diversifying your portfolio is another method of mitigating risk and reducing the effects of volatility, while gaining exposure to potential return opportunities. This mainly involves never putting "all your eggs in one basket," and instead:
- Trading multiple cryptos like Bitcoin and Ethereum or Solana
- Investing in various asset classes (i.e. individual cryptos, tokenized assets, stablecoins, etc.)
One way traders can easily and automatically adjust their portfolio allocations is by using tools like Quadency's Portfolio Rebalancer.
Calculate your position size
When it comes to entering a trade, one should always consider the 2% Rule:
Never allocate more than 2% of your available capital in one trade.
To calculate a trade position size, there are a few elements to take into account:
- Account size – the total size of your portfolio
- Account risk – the percentage of your available capital you’re willing to risk on a trade
- Invalidation point – your stop-loss, or the maximum amount you are willing to lose
Here's the formula to calculate position size with an example:
position size = account size x account risk / invalidation point
position size = $10,000 x 0.02 (2%) / 0.05 (5%)
position size = $4,000
3 - Key Tools for executing your risk management strategy
Learn how Quadency enables traders to proactively design and carry out an investment risk management plan to protect their digital assets.
Remove emotion with automation
One of the many reasons Quadency focuses on trading bots is to help investors take emotion out of the equation, while their bots do all the hard work. And there’s a bot for every investing strategy whether you plan to use technical analysis, scalping, or simply accumulating to HODL:
- For HODLERs: check out the Accumulator bot to automate buys regularly over time, paralleling a DCA (Dollar Cost Average) strategy.
- For technical analysis-based trading: Quadency’s indicators-based automated strategies allow you to enter long position using indicators like MACD, Moving Average, RSI or Bollinger Bands. For more advanced technical analysis, investors can use the customizable TradingView bot, which monitors alerts from your TradingView account to instantly execute trades.
- For scalping: you can use Grid Trader and Market Maker bots to capitalize on small price movements during volatility.
With Quadency’s unique blend of cross-platform portfolio management and easy-to-set-up automation, traders have a wealth of strategies to use for managing risk.
In order to determine the risk taken within a trade, you need first to define your exit point, and whether it end with a loss or a profit:
- The Stop-Loss is a price limit that traders set up so that when the limit is reached, the trade position automatically closes to prevent additional losses. It can be fixed or trailing.
- The Take Profit (or Target Profit) closes a trade position when a specific profit target is reached, after which profits are locked in.
Carefully consider the size of your SL/TP using technical analysis. If the price change is too small it may trigger too soon and vice-versa.
Setting up a Stop-Loss/Take Profit is easy with Quadency bots, including the Bollinger Bands and Smart Order bots.
Calculate your Risk Reward Ratio
Once your SL/TP are set, you can calculate the Risk-Reward Ratio (R/R) to help with risk management. As you can see in the visual below, calculating the RR is simple: Divide your Take Profit by your Stop-Loss; then, compare it to your usual win rate to see if a trade has a higher chance of profit.
With Quadency, it's easy to calculate your R/R when placing a manual trade. As you can see in the visual below, simply use the Stop & Target drawing tool to visualize your R/R.
Avoid a single failure point
As a crypto trader, having only one exchange or one wallet can be dangerous:
- Exchanges that hold the private keys to your crypto could get hacked.
- If you control your private keys but only have one wallet, the keys could get lost.
2 key ways to avoid a single point of failure:
- Have multiple exchange accounts so if one should fail or get hacked, risk is mitigated by spreading out your crypto assets on various platforms.
- Use platforms like Quadency to track all your exchange accounts from one place through encrypted API connections.
One benefit of API trading that many investors may not realize is that when exchanges experience outages during trading peaks, their API trading systems are often still operational, allowing you avoid potential losses.
Crypto markets may seem complex at first. But the digital nature of crypto enables traders to easily set up automated risk management strategies via platforms like Quadency. First, learn the risks of trading digital assets and do your own research. Then choose your strategy and commit to taking action towards removing emotions from your investment decisions. At Quadency, we’ve got a bot for that, and it’s free!
Quadency is a cryptocurrency portfolio management platform that aggregates digital asset exchanges into one easy-to-use interface for traders and investors of all skill levels. Users access simplified automated bot strategies and a 360 portfolio view with a free account.
Disclaimer: The content of this article is for general market education and commentary and are not intended to serve as financial, investment, or any other type of advice.