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    Gate.io Blog What are the reliable risk management strategies?

    What are the reliable risk management strategies?

    25 November 21:18

    TL: DR



    • 1. Risk is the possibility of unfavourable outcomes in trade, which is intrinsic in all types of investment, including crypto, stocks and real estate.

      2. Cryptocurrency risk management identifies, assesses, and manages the risks associated with this class of assets.

      3. The significant types of risk in crypto investment are price risk, technology risk and regulatory risk.

      4. It is essential to incorporate risk management into your overall crypto trading strategy because the ability to respond to risk could be what makes or breaks your experience trading cryptocurrencies.


    Introduction



    Source: Pixabay

    Risk management is critical for any investment to reduce the adverse outcomes associated with trading. All types of investments, including real estate and stocks, involve risk. However, the speculative nature of cryptocurrency value and the volatility of today's crypto markets demand special attention, particularly from new investors. A measured approach to risk management when trading cryptocurrencies will cushion any losses you may incur during your trading journey and assist you in making the most of your initial investment.


    What is Risk Management?



    Cryptocurrency risk management involves identifying, assessing, and managing the risks associated with this class of assets. It is crucial for cryptocurrency investors because of the volatility and uncertainty of the market. By managing these risks, you can protect your investment and increase your chances of maximising profits. Risk is the possibility of unfavourable outcomes in your trade and investment. Hence, long-term crypto trading requires planning against these unfavourable outcomes.


    Types of Risk



    For cryptocurrency, there are three significant types of risk: price risk, technology risk, and regulatory risk.

    1. Price Uncertainty

    The risk of downward movement of crypto price is known as price risk. It is a risk that all cryptocurrency investors face because the price can swing dramatically. This uncertainty implies that your investments could suddenly plummet in a short period.

    The risk of price uncertainty can be mitigated by diversifying your investments rather than putting everything on the line. Keep an eye on cryptocurrency news and trends to have a grasp of where the market is heading.

    2. Technology Risk

    No cryptocurrency project has a 100 per cent assurance of success. The project may fall through or end up being shelved due to technological issues. This unfavourable outcome could happen for various reasons, including the project team's inability to deliver on their promises or a lack of funds to continue development. The best way to mitigate technology risk is by conducting research before investing. You should only invest in cryptocurrency projects you believe have a good chance of success. Before making a final decision, it would also be beneficial to read reviews and opinions from other investors and read about the team behind the project.

    3. Regulatory Risk

    Cryptocurrency projects also face the risk of government regulation or outright ban. This regulatory challenge could happen if cryptocurrency is perceived as a threat to the existing financial system or is used for illegal purposes.

    Before investing in cryptocurrency, you should be aware of the regulatory risk in your country. Governments have shut down cryptocurrency exchanges in some countries, including China and South Korea. Investors should always conduct research to understand their country's regulatory risks.



    Reliable Risk Management Strategies



    1. Determine your risk tolerance

    The golden rule is that you “never take a risk that you cannot afford to lose. Every trader should know the precise risk level they can tolerate. Determining one's risk tolerance and tailoring it to one's crypto investment strategies should be standard practice.

    To begin, calculate the risk-reward ratio for each crypto pair. Second, decide how much money you're willing to risk for the time being and stay within that limit.

    Cryptocurrency trading requires a great deal of self-discipline. When the market is up, putting in more money than you had planned can be very enticing. However, keep your emotions under control and let logic, not hype, guide your decisions.

    2. Position Sizing

    Position sizing is an important risk-management technique when dealing with any investment, which includes crypto assets. The preservation of capital and preventing any catastrophic losses should be your top priorities when choosing your position size. Catastrophic losses are total losses from which one may never recover.

    The Fixed Percentage Position Sizing Model is widely used because it is simple to understand and implement. This model is also suitable for beginners as it does not require any prior trading experience. For this model, a good rule of thumb is to not risk more than 2-3% of your account in a single trade.

    Assume you're willing to take a $50 loss per crypto contract as your stop-loss. In this example, your trading account contains $20,000. You want to keep your risk per trade to no more than 2% of your trading capital.

    Fixed Percentage x Trading Capital = Risk Per Trade

    2% x $20,000 = risk per trade

    $400 in risk per trade

    After calculating the risk per trade, you can determine how many contracts size you can afford.

    Risk per trade / Risk per contract = Position Size (Number of Contracts)

    $400 / $50 = 8 Position Size

    3. Conduct research

    It is a known fact that some crypto projects are more vulnerable to security issues and infractions than others. Some native tokens or coins carry significant liquidity risks, such as hype volatility swings. It would be beneficial for you to understand these distinctions so you can put a good risk management plan in place.

    The risks associated with specific cryptocurrency coins do not exist in a vacuum. Your trading ecosystem is as crucial as your coin. If you are not cautious of your wallet or trading platform selection, you may suffer a significant loss on your cryptocurrency investment. The same is true for your understanding of crypto-related con artists and scams; malicious agents can take advantage of you and your assets if you aren't in the know.

    After conducting your research, your coin selection should reflect your risk tolerance and personal preferences, such as privacy and ease of use. If all of these are in sync, dealing with the risks that come your way will be easier.

    4. Understand Risk to Reward ratio

    After researching your coin options, the next crucial step in managing crypto risk is figuring out your risk-to-reward ratio and how risk fits into your investment strategy. The risk-reward ratio compares your actual risk level to your potential returns. In simpler terms, it is the amount a trader is willing to risk or lose per trade. It helps you determine how long you are supposed to stay on a market trend.

    5. Protect yourself with a stop-loss order

    Another clever way to handle cryptocurrency risk is to use a stop-loss order to protect your investment position. You can set a stop-loss order that will be executed automatically if the asset price falls below a certain level. This will keep you from losing too much of your investment and will help you keep to a risk-reward ratio.

    Let's look at a simple stop-loss example:

    If you buy a crypto asset for $2,000, you could set a stop-loss order for 10% below the price you paid, so that when the asset's value falls to $1,800, it will be automatically sold. In other words, your losses are limited to 10%.

    6. Diversify Your Portfolio of Investments

    You should also refrain from pinning all your investment hopes on cryptocurrency. While crypto investments can be highly profitable for those who play their cards correctly, they are neither a panacea nor an adequate substitute for a well-balanced and diversified investment portfolio.

    Consider your crypto assets as just one type of investment among many that can help you increase your wealth. Knowing this, work on developing an investment portfolio that spreads your risk. When the value of one asset class fluctuates, the other investments will help to balance it out and keep you out of the red.

    7. Prepare an Exit Strategy

    Finally, while you may not want to consider the circumstances that would force you to stop trading in your preferred cryptocurrency, it is critical to plan an emergency exit strategy. You should be able to tell when it's time to switch to another coin or stop trading altogether.

    If you've decided on an entry amount for your crypto venture, you should also decide on the inverse. It is referred to as an exit amount and can serve as a concrete benchmark for preventing catastrophic loss.

    Having an exit strategy, however, should encourage you to put forth your best effort when trading in cryptocurrency. Consider it more like making every minute you've spent on crypto investments count. Recognising the possibility of things going wrong may encourage you to be more strategic in your crypto trading decisions.


    Conclusion



    Trading cryptocurrencies involves risk, hence the need for intelligent risk management rather than denial. Incorporate risk management into your overall crypto trading strategy using the above tips so you can shield your portfolio from dramatic losses.




    Author - M. Olatunji, Gate.io Researcher

    Disclaimer:

    * This article represents only the views of the observers and does not constitute any investment suggestions.

    *Gate.io reserves all rights to this article. Reposting of the article will be permitted provided Gate.io is referenced. In all other cases, legal action will be taken due to copyright infringement

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