Risk management is an integral part of responsible investing and trading. It helps reduce the overall risk of a portfolio in a variety of ways. For example, users can diversify their investments, hedge risk within specific financial events, or use simple stop loss or take profit orders.
Introduction
Risk reduction is a top priority for many investors and traders. Even if a particular trader's risk tolerance is quite high, it is still crucial to assess whether it is worth the possible reward. However, risk management is not just about choosing less risky trades or investments. Risk management strategies offer a set of tools that are suitable for experienced investors and novices alike.
What is risk management?
Risk management involves anticipating and identifying the financial risks associated with an investment to further minimize them. Investors apply a risk management strategy to reduce the risks of their portfolio. To begin with, it is necessary to assess the current level of risk and then build further plans around this.
Risk management strategies are planned actions that traders and investors take after identifying investment risks. These strategies can include a wide range of financial measures, such as insurance against losses and diversification of the portfolio across asset classes.
In addition to implementing risk management measures, it is important to understand the basics of risk management planning. There are four basic planning methods that should be considered before embarking on a specific risk management strategy, as it will be based on the method chosen.
In addition to implementing risk management measures, it is important to understand the basics of risk management planning. There are four basic planning methods that should be considered before embarking on a specific risk management strategy, as it will be based on the method chosen.
The four basic methods of risk management planning
- Acceptance: the decision to take a risk and invest in an asset without spending money to protect against potential losses because they are small.
- Transfer: transferring the risk of an investment to a third party for a fee.
- Avoidance: not investing in an asset with potential risk.
- Reduction: reducing the negative financial consequences of a risky investment by diversifying the portfolio. This technique can be implemented within the same or different asset classes and industries.
The importance of a cryptocurrency risk management strategy
Cryptocurrencies are the riskiest investment asset class available to the average investor. Cryptocurrency prices can be extremely volatile, some projects fail (like Luna), and blockchain technology can be quite complex for most to understand.
Because the cryptocurrency industry is rapidly evolving, it's crucial to utilize sound practices and strategies to reduce potential risks. They also help you become a more successful and responsible trader.
Read on to learn about five risk management strategies you can use to protect your cryptocurrency portfolio.
Because the cryptocurrency industry is rapidly evolving, it's crucial to utilize sound practices and strategies to reduce potential risks. They also help you become a more successful and responsible trader.
Read on to learn about five risk management strategies you can use to protect your cryptocurrency portfolio.
Strategy #1:
The 1% Rule
The 1% Rule is a simple risk management strategy where no more than 1% of the total capital is at risk when investing or trading. If a trader has $10,000 to invest and wants to adhere to the 1% rule, he can do so in several ways.
He can purchase $10,000 worth of bitcoin (BTC) and set a stop loss or limit stop order to sell at $9900. In this way, losses can be reduced to 1% of the total investment ($100).
In addition, you can buy $100 in ether (ETH) without setting a stop loss because if the price of ETH drops to 0, the losses will be no more than 1% of the total capital. The 1% rule does not affect the size of the investment, but rather the amount a trader risks when investing.
Due to the volatility of the market, the 1% rule is especially important for cryptocurrency investors. In the pursuit of profit, many traders may invest too much and suffer huge losses in the hope of luck.
He can purchase $10,000 worth of bitcoin (BTC) and set a stop loss or limit stop order to sell at $9900. In this way, losses can be reduced to 1% of the total investment ($100).
In addition, you can buy $100 in ether (ETH) without setting a stop loss because if the price of ETH drops to 0, the losses will be no more than 1% of the total capital. The 1% rule does not affect the size of the investment, but rather the amount a trader risks when investing.
Due to the volatility of the market, the 1% rule is especially important for cryptocurrency investors. In the pursuit of profit, many traders may invest too much and suffer huge losses in the hope of luck.
Strategy #2.
Setting stop loss and take profit points
A stop loss order sets a certain asset price in advance at which the position will be closed. The stop price is set below the current price and when activated helps to protect against further losses. A take profit order acts opposite to a stop loss, setting a desired price to close a position to lock in a certain profit.
Stop loss and take profit orders help manage risk in two ways. First, they can be set up in advance and will be executed automatically. The trader will not have to trade around the clock, and pre-set orders will be executed during periods of price volatility. This also allows you to set realistic loss and profit limits that the trader is willing to accept;
Try to set these limits in advance, not at the most crucial moment. It may be unusual to use take profit orders for risk management, but you should not forget: the longer you postpone profit taking, the higher the risk of another market crash.
Stop loss and take profit orders help manage risk in two ways. First, they can be set up in advance and will be executed automatically. The trader will not have to trade around the clock, and pre-set orders will be executed during periods of price volatility. This also allows you to set realistic loss and profit limits that the trader is willing to accept;
Try to set these limits in advance, not at the most crucial moment. It may be unusual to use take profit orders for risk management, but you should not forget: the longer you postpone profit taking, the higher the risk of another market crash.
Strategy #3:
Diversification and hedging
Portfolio diversification is one of the most popular and basic tools for reducing overall investment risk. Portfolio diversification helps to avoid investing too heavily in any one asset or asset class, which reduces the risk of large losses from it. For example, an investor can hold many different coins and tokens and provide liquidity and loans.
Hedging is a more advanced strategy of protecting profits or minimizing losses by buying another asset. It usually involves opening an opposite position. Diversification can also be a type of hedging, but futures are most commonly used as part of this strategy.
A futures contract allows the price of an asset to be fixed at a date in the future. Suppose a trader expects the price of bitcoin to fall and decides to hedge against this risk by opening a futures contract to sell BTC for $20,000 in three months. If the bitcoin price does fall to $15,000 in three months, he will make a profit on his futures position;
It is worth remembering that futures contracts are settled in currency without the need to send coins. In this case, the other side of the transaction pays the trader $5000 (the difference between the spot and futures price), which allows to insure against the risk of bitcoin price drop.
As mentioned above, cryptocurrencies can be extremely volatile, but traders can diversify their portfolios within this asset class and utilize hedging opportunities. Diversification is much more important in cryptocurrency than in traditional financial markets with less volatility.
Hedging is a more advanced strategy of protecting profits or minimizing losses by buying another asset. It usually involves opening an opposite position. Diversification can also be a type of hedging, but futures are most commonly used as part of this strategy.
A futures contract allows the price of an asset to be fixed at a date in the future. Suppose a trader expects the price of bitcoin to fall and decides to hedge against this risk by opening a futures contract to sell BTC for $20,000 in three months. If the bitcoin price does fall to $15,000 in three months, he will make a profit on his futures position;
It is worth remembering that futures contracts are settled in currency without the need to send coins. In this case, the other side of the transaction pays the trader $5000 (the difference between the spot and futures price), which allows to insure against the risk of bitcoin price drop.
As mentioned above, cryptocurrencies can be extremely volatile, but traders can diversify their portfolios within this asset class and utilize hedging opportunities. Diversification is much more important in cryptocurrency than in traditional financial markets with less volatility.
Strategy #4:
A prepared exit strategy
A prepared exit plan is a simple but effective method of protecting against large losses. By sticking to the plan, a trader will be able to make profits or cut losses at a predetermined point in time.
If traders make profits, they can forget about caution and hold a position even when prices are falling. In addition, the user's actions may be influenced by hype, maximalism or the mood of the trading community.
To successfully implement an exit strategy, it is recommended to use limit orders. They can be set to trigger automatically at the limit price both to fix profit and to limit the maximum loss;
If traders make profits, they can forget about caution and hold a position even when prices are falling. In addition, the user's actions may be influenced by hype, maximalism or the mood of the trading community.
To successfully implement an exit strategy, it is recommended to use limit orders. They can be set to trigger automatically at the limit price both to fix profit and to limit the maximum loss;
Strategy #5:
Own research
Doing your own research (FA and TA) is an important part of any investor's risk reduction strategy. In the age of accessible internet, it is not difficult to verify information. Before investing in a token, coin, project or other asset, be sure to check the available information. It is crucial to review the technical documentation, tokenomics, project partners, as well as the roadmap, community, and other fundamental information.
However, it's worth keeping in mind that misinformation spreads pretty quickly, and on the internet, any user can call their opinion facts. When conducting research, use reliable sources of information and consider the context. Cryptocurrency shilling is common, and some projects or investors may intentionally pass off false, biased or promotional news as truth.
However, it's worth keeping in mind that misinformation spreads pretty quickly, and on the internet, any user can call their opinion facts. When conducting research, use reliable sources of information and consider the context. Cryptocurrency shilling is common, and some projects or investors may intentionally pass off false, biased or promotional news as truth.
Summary
The strategies described above offer a fairly effective set of tools to reduce portfolio risk, albeit simple enough for the experienced trader, but no less effective, especially if you, dear reader, combine them with each other.
Even using simple methods that cover most areas will help you approach investing more responsibly. Experienced traders can try advanced risk management plans with in-depth strategies.
Good luck dear friends, and remember that Fortune favors you when you are with Meta Joker ;)
Even using simple methods that cover most areas will help you approach investing more responsibly. Experienced traders can try advanced risk management plans with in-depth strategies.
Good luck dear friends, and remember that Fortune favors you when you are with Meta Joker ;)
