I do not want to pretend at all that crypto is not risky. Crypto is very, very risky, for sure. But we have to remember that the same thing that makes crypto risky also makes it super profitable. If you understand how to properly manage your risk, you can capitalize on all of that volatility or the movements of crypto in order to make profits and minimize that risk. So how do you do that? How can you manage your trading risks? How do you tell if you’re progressing or heading in the wrong direction?
In this blog, I will walk you through my absolute risk management strategy in crypto trading- the very simple list of things that I’ve learned about cryptocurrency trading so far.
Specifically, we’ll be discussing the following types of risk management strategy:
- What is a stop loss
- How to manage your stop loss
- How to make sure that your profitable trade doesn’t go negative
- Reward to risk needs to be at least 2:1 or greater
- Physical vs. mental stops
Honestly, some traders forget that crypto trading is not just about earnings, but also about risks, as the crypto world continues to grow big. And if you don’t want to drain your account on the very first day, you have got to keep a risk management strategy in mind.
What is a Stop Loss?
When you’re day trading, you have to protect yourself against a move in the opposite direction. So you always have something called a stop loss that kicks you out of your position if the trade goes the wrong way. Yes, you lose a little bit of money, but that protects you from losing a lot.
A stop loss is a conditional market order. Usually, it’s based on the condition that the market price makes it to a certain amount. So let’s say we were buying Litecoin at $100, and we put a stop loss at $98. What that means is that, when the market price of Litecoin reaches $98, we immediately execute a market order to sell all of our position on Litecoin.
When a preset price level is reached, the stop-loss order becomes active. Many traders use this to sell their positions when the value of a certain currency falls below a specified level. Because cryptocurrencies are so volatile, having a stop loss in place ensures you don’t lose a big amount of money if the currency drops.
A lot of people who trade crypto on leverage do not use stop losses. This might work during a bull market as we saw two years ago when the prices of crypto just keep going up and up. But if there’s a crash one day out of nowhere, like we saw in May, all those people were stuck back holding.
I’ll let you into a little secret. I was one of those people. Up till then, I did not think I needed to stop losses. But I learned my lesson real quick.
How to Manage a Stop Loss
When you’re day trading crypto, set your daily stop-loss before you start. It may fluctuate depending on the strategy used to determine your daily stop-loss. But, if you’re just starting out trading and goal in mind, your daily stop should be based on a loss percentage or a string of losing deals. Using both strategies is good since it allows you to develop a baseline and a daily stop-loss habit.
Stop trading if you lose around 1-3% of your account in one day. After you’re frustrated, try stopping for the day or at least taking a 15-minute break if you’ve lost a few trades in a row.
Here’s how you can place a Stop Loss in Phemex:
How to Make Sure That Your Profitable Trade Doesn’t Go Negative
Cryptocurrencies, like any other capital asset, can be profitable or lose money. The day trading crypto is not that easy, and as a trader, you should only invest money that you can afford to lose. Despite the fact that the recent market crisis was not anticipated, it occurred. Other crashes have occurred in the past, and more are likely to occur in the near future. Even if you follow the rules to the letter, there is never 100% assurance that you’ll get your money’s worth.
Now that you’re aware of some of the dangers, here are the top 5 rules that every new crypto trader should remember:
- Never trade without a stop loss (as mentioned above). Even if it’s just a mental stop loss always have a stop loss.
- Never go into a trade without a plan. And when I say a plan, you have to have a plan for- if the asset that you’re trading goes up, goes down, or goes sideways.
- If you’ve had several stop outs in a row and you’re on kind of like a losing streak, don’t keep trading. Either go back in the simulator or reduce the amount of capital that you’re trading. Remember that as a day trader, protecting your capital is your number one job. Making money is only number two.
- Think that somehow you either have the discipline or you don’t. Successful day traders continuously work on their psychology and their discipline.
- Never ever let a winning trade go negative.
This comes down to the number one rule of day trading, which is: protect your capital at all costs, then you can worry about making money. So specifically, if you’re in a trade, you want to have some sort of profit target, and at that profit target is your determination that you are in profit. At that point, you want to put your stop loss into profit just above where you entered or below if you’re in short. So that worst-case scenario you break even on that trade.
I personally use 1%. I think anywhere between 0.75 and 1% is a good profit target. Since I’m a day trader, I tend to do things a little bit more tightly. a swing trader might use a little bit of a looser profit target, maybe 5% or 10%. But the idea is to protect your profit once you determine that you have them.
Reward To Risk (RR) Needs To Be at Least 2:1 or Greater
When you’re trading on leverage, you don’t necessarily have to have a different risk-reward ratio as you would when you’re not trading on leverage. You just have to make sure that the risk-reward ratio that you’ve calculated, on both sides includes the fact that you’re trading on leverage.
So when I’m trading on 5x and I calculate my profit target, I calculate it including leverage. 2% profit is my profit target, including the fact that I’m on 5x leverage. So it’s actually going to be 0.4% market movement, which is going to equate to me getting 2%. Similarly, when I’m calculating my stop loss, it also includes leverage. I actually work with like, a 0.2% loss in terms of market movement, which equates to a 1% loss for my account.
If you have a strategy that works, you want a risk to reward of at least one, and in terms of my risk-reward ratio, it’s usually two to one at the very least. So my profit target is at least 2% and my risk is always 1%. But depending on the setup, I may go for more, and usually, I do that with a mental trailing stop, which I’ll discuss in the next paragraphs of this blog post.
Physical vs. Mental Stops
You can limit your losses while day trading crypto by using a stop loss.
Either you can use a physical stop, which is on exchanges (places where you can day trade crypto, like Bybit or Phemex) and they allow you to put in a conditional market order. For example, if you were to buy Litecoin at $100 and you specify that if Litecoin drops at or below $98 you want to sell, you can actually put a physical stop loss at $98. That way if the price drops to or below $98, your position will be sold and thus you are stopping your risk. So if you are trading not on leverage (spot trading), that would be a 2% risk.
You can also implement mental stops. In here, you are actively watching your trade, and the second that you see the price either reaching or coming close to where you’ve decided to exit the position if it goes to that point, then you just immediately sell your position.
- Physical stop: Should not be tighter than 1.5% on leverage
- Mental stop: Should not be tighter than 1% on leverage
Here’s a video of mine explaining further what mental stops are all about:
My Final Thoughts About My Risk Management Strategy
What is a good way to manage risk when trading cryptocurrency, specifically trading cryptocurrency on leverage? Did you find your answer in this blog post?
First of all, we don’t want you to even close to being liquidated. Liquidated means everything you put into the trade is gone, which essentially means that if you do trade that way, your risk management is saying that you are willing to lose 100% of the money that you put into the trade.
Some people get around this by only trading with a certain small percentage of their capital, so they manage risk by saying “Okay, if I have $100 then I’m going to use five of those dollars in this trade a.k.a 5% to my account. I am not going to stop loss or anything.” And thus, they are risking 5%.
The way that I trade is that I put 100% of my account or as close to it as I can into the trade, but then I set my risk to 1% using a mental stop loss. You can also do this using a physical stop loss and that is how I personally manage risk when day trading.
Are you going to lose ALL your money on leverage trading?
If you are trading properly on leverage, you should never be in the position where you’re going to lose all your money. I’m always advocating for practicing in the simulator, which means you are trading with fake money. And so losing money at all isn’t an option. You’re not even gonna lose $1 or one cent.
And if you’re a beginner or if you’re currently losing money day trading, or if you are practicing a new strategy in your crypto day trading whatever it might be, if you are not consistently profitable, you should be in the simulator. This means fake money, which means there’s NO WAY that you should be losing any money at all.
Meanwhile, if you are trading with live money, which means that you are already consistently profitable in the simulator, you should always be using a stop loss.
In the simulator, I say you can use a looser stop loss like 5%. Typically I trade with very tight stop losses, sometimes as tight as 1%. In fact, typically I trade with a 1% stop loss. So I would have to lose 100 trades in a row fully stopped out to lose all of my money. And that typically doesn’t happen. The reason is:
- I practice so much in the simulator at this point that I almost never get stopped out at full stop.
- I have a rule that I use for myself and my students that if you get stopped out three times in a row, you switch to the simulator. Therefore, you should not continue to trade live if you’ve just been stopped out three times in a row.
There is literally no way that you should ever be in a position where you’re going to lose all your money.
As a day trader, your income and your livelihood depend on the fact that you have the capital to trade. If you have no capital to trade, you are not a day trader. So being a day trader, your number one job is risk management and protecting the capital that you have. Because that is literally the only way you can keep working.