HomeStep-by-Step Guide to Risk Management for Crypto Traders
Step-by-Step Guide to Risk Management for Crypto TradersLevel: Beginner
Samuel McCulloch
Head of Adara Academy & Trading division. Professional crypto trader with experience in capital markets, options and futures trading.

According to several statistics, as many as 70% of all lottery winners end up filing for bankruptcy. Winning a lot of money once does not necessarily mean having money in the long run. The same principle applies to trading crypto.

Making high profits on your good trades doesn’t matter if you lose more than you make in the long run. What does matter is making a consistent profit. In this sense, minimizing risks and cutting losses is just as important as finding winning trades. In fact, it may be more important because a bad loss can wipe out your capital and make further trading impossible.

Fortunately, a strong risk management strategy can keep you in the game and maximize your profits. Below, we guide you through 6 steps that will do just that for you, even if you’re a complete beginner to trading.

Step #1 is to…

1. Have a Plan

The biggest risk in trading doesn’t come from bad assets, depreciating coins, or even cybercriminals. In fact, an advanced trader can continue to make money in a bear market where everyone else seems to be bleeding money.

Instead, the biggest risk in trading is the human factor. A single bad decision, a single instance of overextending, a single all-in trade that ends badly is enough for even the best trader to lose everything they have and undo all previous good decisions.

That’s why the old adage of “plan the trade and trade the plan” is the first law of effective risk management. If you want to make money in the long run, you can’t treat trading like gambling. You can’t base what you’re doing on in-the-moment feelings and emotions.

Instead, you need a plan: a system of trading rules that takes as many decisions as possible out of the equation. A trading system includes things like your desired risk, the kinds of coins you want to buy, how you react when you lose money, and many other things.

Over time, you can fine-tune your plan so it gives you the results you want and need. This is how you minimize risks, maximize profits, and stay in the game.

Don’t assume that your plan needs to be perfect or even profitable; what matters is having one, even if it’s not instantly effective. And one of the very first things you’ll have to decide when making a trading plan is…

2. Figure Out Acceptable Risk Levels

If you’re going to trade, you’re going to lose some trades. This is fine. What isn’t fine is losing so much money that you lose some or all of your capital. To this end, it’s important to know just how much money you’re willing to lose per trade.

Numerically, you need to understand your maximum acceptable risk. This is a percentage that defines the amount of money you’re ready to lose per trade. For example, if you have $100,000 in fiat money and are prepared to lose $1,000 per trade, your maximum risk is 1%.

Knowing your maximum risk lets you exit trades once they lose you too much money. This can be the difference between losing 1%, 5% and 20% - so it’s important.

Numbers aside, it’s good to define your general approach to risk. Some traders find that high-risk, high-profit trades are a good match for their strategy and personality. Others discover the opposite: that low-risk positions work better for them. There’s no right answer; what matters is that you have a clear idea of how much risk you can take on, both per trade and in the long run.

3. Get Ready to Execute Your System

Successful trading is about creating a system of rules, then using and improving it. This is one of the first things any crypto trader learns on the job. The catch is, having a system and executing on it is not the same thing.

In fact, most traders - even the ones who always lose - have a solid trading system. They’re not hard to come by. If you don’t have one, you can just go to Adara Academy where we guide you and any other trader through making your first profitable trading system.

So why does the average trader fail consistently, even after buying or copying a more advanced trader’s strategy to a T?

By getting distracted while using a crypto exchange and missing out on opportunities. By giving in to temptation and making trades that don’t fit in with their plan or system.

You don’t want this to be you. You want to be ready to execute your strategy no matter what happens. This means:

  • Practicing with your trading platform’s test/demo mode so you know exactly what to do when it’s time to make a trade.
  • By trading in a quiet work environment where you’re not distracted or tempted to multi-task.
  • Accepting that a lot of the time, you’ll have to refuse trades that feel good in order to stick to your plan.
  • Refusing to trade at times when your judgement may be impaired; for example, after a big loss or win.

There are more ways to stay on task, of course. For example, some traders switch off their phones to make sure they’re locked in when they’re working. The point is that you should do whatever it takes to act on your plan consistently, and avoid trading when you can’t.

Something you may want to pay special attention to is…

4. Know When to Enter and Exit a Position

When you buy a surging coin or see yourself making a profit, trading gets fun. It’s tempting to hold on to your asset for as long as possible. After all, your coin might appreciate and even if it doesn’t, you’ll still have won if you manage to sell on time.

This works both ways. If you’ve got fiat money and you’re waiting to buy a coin, it’s fun to try and guess where the bottom’s going be. If you manage to get it right, you maximize your profits - and if you don’t, you’re still likely to buy near the bottom.

Unfortunately, these minor decisions can actually lose you a lot of money. That’s because waiting for the perfect moment is likely to result in several things.

The first is slippage, wherein your order gets filled at an inferior price due to rapid price movements and low liquidity. The second is complete failure to execute, wherein your order doesn’t get filled at all (for the same reason). The third is the opportunity cost of focusing on maximizing profits rather than finding new profitable trades.

The solution to all these problems is not being greedy. Instead of trying to milk each trade for each and every penny it’s worth, know exactly when you need to enter and exit a position and execute with discipline.

It may sting to see a coin you just sold appreciate further once you’ve sold it, but here’s the catch. Unless you’re a one-in-a-million trader, you can’t anticipate price peaks and troughs with 100% accuracy. Trying to do so is a form of gambling, which means it has no place in profitable, systematic trading.

What you want to do instead is have a plan for entering and exiting each trade. Once you’re ready to buy a coin, simply follow the plan and don’t get greedy barring rare circumstances like a Q4 2017-style surge. For extra security, follow the next step to minimize losses further.

4. Use Stop Losses (With Temperance)

A trader who wins loads of trades isn’t necessarily more successful than one who usually loses. A low win-rate strategy can still be very profitable if your profits run a long time and exceed small tick tack trades.

Additionally you can lock in profits with stop-loss orders. We explain these in detail in the free Adara Academy section on risk management, but here’s what you need to know.

A stop-loss order will automatically turn into a limit or market order if a coin reaches a certain price point. For example, you can set a stop loss that sells a coin off if you exceed your maximum risk. Alternatively, you can set a stop loss after you’ve made a profit to make sure you don’t lose money after a winning trade. Either way, you’re reducing your risk significantly.

One thing to watch out for with stop losses is the stop out. This is when a stop order is triggered in a way that loses you money. For example, let’s say you buy into a coin at $100 with a stop loss set to sell at $99.

Next, the coin’s value falls to $98.9 before roaring back up to $120. Not very good for you, right? You’ve managed to stay within your maximum risk boundary, but you’ve lost a lot of potential money because of your stop loss.

The lesson here is to always use stop losses while understanding their limits. Simply setting a stop order is no guarantee that you won’t lose money. Being mindful, careful, and watching the markets you’re invested in is still important.

5. Learn Spot Trading Before Using Leverage

Margin trading means borrowing money from an exchange in order to fund a trade. For example, you can use 10x leverage to buy $1,000 worth of a coin with just $100 on your account. This lets traders make far more money than they could otherwise.

The catch is that if a trade loses money, your money goes first. In the above scenario, a 10% loss in your $1,000 coin position means you lose your entire $100. At this point, your balance will be liquidated in order to return the borrowed money to the exchange.

Due to this mechanism, it’s hard to use margin trading while keeping to a low maximum risk figure. You don’t want to start trading with leverage until you’re confident with spot trading, i.e. trading using the money on your balance.

6. Get Comfortable With the Idea of Losing

This may sound harsh, but remember that the market doesn’t care how bad you want to win as a crypto trader. Some days, you’ll do everything perfectly - execute your strategy, set effective stop losses, create a productive work environment, etc - and still lose money.

This. Is. Fine.

The fact is that no living trader wins every single trade they open. The key is simply winning more money than you lose over a long period of time. So long as you can do that and stay in the game, you’re winning.

So don’t be nervous. No matter what you do, you’ll lose money at one point or another. What matters is that you stay calm in the face of (temporary) defeat, continue executing your strategy, and wait for the tide to turn in your favor so you can make a tidy profit.

After all, so long as you follow the tips in this article, you’ll never lose more money than you can make back comfortably. So remember these steps, use them, and you’ll always live to make more money another day.