Cryptocurrency trading has been emerging in recent years with many traders and institutional investors investing a lot of money in it. Similar to forex markets, crypto markets are very volatile and hence investors are more prone to loss easily.
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Cryptocurrency markets have formalized the beginning of a new financial evolution by introducing Bitcoin to the world in 2009. The inherited profit potential and the novel crypto concept attracted investors and since then, crypto markets have been growing with a large amount of trading worldwide.
This article will help you to know what are the risks of trading crypto and how to manage them effectively to minimize substantial losses.
Quick insights
Risks of trading cryptocurrency
Ever since the launch of Bitcoin, crypto markets have been on a fast-paced advance due to its attractive returns. However, we should not underestimate the risks involved in trading cryptocurrencies as crypto is one of the most volatile markets in the world. Even a small mistake in crypto trading may lead to substantial loss. Below are a few of the important risks of investing in cryptocurrency.
Volatility
The crypto market is known for its volatile nature due to a large number of traders participating worldwide and numerous factors affecting the market. There are so many instances in the history of cryptocurrencies, where huge spikes and steep falls occur as evident from their charts. Those large moves are the causes of volatility in the market due to several reasons.
One of the best ways to handle volatile markets is by widening your level of risk in the trades. In a speculative market like crypto, where the market can fluctuate rapidly in either direction more often, fixing stop losses is very crucial.
In such cases, traders should take into consideration the volatility in the crypto market, before deciding the stop losses. Moreover, traders should also reduce the risk exposures of their trades to limit the downside risk.
Liquidity
Liquidity of a financial asset class refers to the ability to buy or sell it without changing the market price much. In order to enter into a trade, one should have enough buyers or sellers so that the crypto asset can be converted into cash easily. When there are not many sellers to match your buying size, then the market has to move to higher levels to attract more sellers.
If a trader wants to exit his large position, it is necessary that the cryptocurrency should have enough liquidity to fill his position. If not, the currency may witness a fall thereby not allowing him to exit at his desired price. This is more common and often happens in the crypto market.
The liquidity of a crypto is generally affected by,
- Time of the trade
- Day of the week
- Size of your position
- Spot exchange you are trading with etc.
More popular cryptocurrencies such as Bitcoin, and Ethereum (Layer 1 Blockchain technology) usually have more liquidity irrespective of the aforementioned scenarios. Hence it is very easy for the traders to enter or exit these crypto hassle-free. The best way to address the liquidity issues of the cryptocurrencies is
- Trading only premium cryptocurrencies that have liquidity all the time
- Trading the minimum of the cryptocurrencies that have smaller pools of liquidity
- Breaking up your large trade into smaller sizes. This helps markets to get time to digest large volumes of trading.
- Spot trading is one of the more liquid ways to trade crypto.
Fraudulent brokers
Cryptocurrency is a largely unregulated market among the other financial markets. There are enormous cases where scammers close the projects after getting investments from the customers. Hackers also keep trying to steal cryptocurrency from your digital wallet. Learn how to transfer crypto between wallets.
When you find a project too promising to provide abnormally high returns then it could be a scam. One should invest money only after doing proper research of the crypto platform and the institution he is opening an account.
Investors should prefer a reputable crypto trading platform with robust security to prevent hackers and more liquid that allows them to trade at a fair price.
Regulatory changes
Regulatory changes are very common and they happen more often in highly volatile and unregulated markets like crypto. Despite crypto not having a single regulatory authority, governments from several jurisdictions may intervene to take development actions in the crypto markets. As a caution effect, traders exit their positions resulting in a fall in cryptocurrencies.
Few governments such as EI Salvador have embraced Bitcoin as an authenticated means of payment in their private dealings. Traders withdraw the funds on scam activities and bankruptcy situations and the government/central banks come forward to settle the disputes and take necessary actions to protect the hard-earned capital of investors.
Emotions
Fear of losing, uncertainty about the situation, and doubt are the most common emotions that have a greater impact on your trading decisions. Specifically in speculative markets like forex and crypto, traders often make emotional trading driven by impulsive decisions.
Leverage
Leverage is a high-risk/high-reward trading strategy that allows crypto traders to take exposure of more than they are capable of with the aim of greater returns. While leverage trading can maximize your returns, it may also maximize your risks and moreover may lead to loss of your capital entirely.
It is necessary to keep your risk profile in mind before tending to open leverage positions in crypto. Maintaining your trading strategy is the best way to avoid a high-risk approach to investing.
Risk management in crypto trading
In order to optimize your crypto portfolio, it is essential to employ effective risk management strategies. It is practically impossible to make consistent profits in any financial market, particularly in a highly speculative market like crypto. Risk management strategies and trading tools typically help us only to mitigate the losses and not eliminate them completely.
The risk management process involves the below steps.
- Identifying the risk
- Assessing and measuring the risk
- Prioritizing the risks to address the issues
- Implementing appropriate strategies to minimize those risks
Conclusion
Traders make flawed decisions due to many common misconceptions and concerns about digital assets. The risks of trading cryptocurrencies can be mitigated by understanding the dynamics of the crypto markets, choosing right crypto exchange platforms, and implementing appropriate risk management strategies at the perfect times.
Explore the top 5 ways to manage risk when trading cryptocurrency.
Pro Tip
Understand the risks involved in crypto trading and learn the risk management strategies with our trusted forex brokers to maximize your returns. Also explore the other investment options such as CFDs, forex, and stocks.
