As the popular saying goes, if you pray for the rain, you gotta deal with the mud too. Opportunity and risk are two sides of the same coin. In all aspects of financial trading, risk management has to be an integral part of a trader’s operations.
CFDs are renowned for their high leverage. Leverage allows a trader to magnify their margin several times when trading. It is also true that trading CFDs incurs heightened risk for traders.
When trading CFDs, you incur significantly more risk because one does not own the underlying asset. Purchasing assets in conventional ways means that you actually own the asset/currency and can sit on your losses. With CFDs, one is purely speculating on prices, and when losses occur, they are sweeping.
To manage the heightened risk, CryptoAltum provides special tools that traders can use to cut risk as they build a Risk Management Strategy.
Why Do You Need a Risk Management Strategy When Trading Crypto CFDs?
When trading leveraged crypto products, you open a position larger than your deposit. This situation provides an opportunity for great profits, but the risks are also magnified should the markets move against you. As leverage goes higher, so does the magnitude of profits or losses.
In trading crypto CFDs, you have to be aware of this risk, especially overleveraging your account. Cryptocurrency markets are especially volatile and can exhibit rapid movements. Bitcoin prices, for instance, move on all manner of developments, including internal coin politics, regulatory developments, and stock markets upheaval.
Slippage, which is the difference between the expected price of a trade and the price at which it is executed, is a feature of volatile markets. Accordingly, prices can rapidly move against a trader and render their initial calculations redundant.
For the aforementioned reasons, risk management has to be a part of every trader’s considerations. These are some of the popular risk management tools in CFD crypto markets.
· Stop loss orders
· Take Profit orders
1. Stop-Loss Orders
The name says it all.
This is a tool that traders can use to stop losses when trading CFDs. A stop-loss sets a bottom price limit below which a trader does not intend to keep their position open. Therefore, a stop-loss closes a position immediately once a certain price is reached.
With a stop-loss, you have a support level. Should prices slide below that point, there is a distinct possibility of further downward movement. The stop-loss tool automatically closes your position limiting further losses.
The use of a stop-loss should be accompanied by sound analysis. Factors like overall market sentiment, how long the order will be open, and prevailing volatility count in informing your stop-loss limit.
A stop-loss ensures that you trade a CFD above a certain price. The stop-loss is not an end in itself, in terms of guaranteeing profitability. A trader still has to make informed market decisions with the stop-loss order only acting as back-up.
Advantages of a Stop-Loss Order
A stop-loss order has the following advantages:
1. It reduces the influence of emotions on decision making. When trading, one can fall prey to phenomena like buying-the-dip and holding too long. Instead, a stop-loss allows you to exit a position when losses are no longer manageable.
2. A trader does not have to monitor price movement all the time. In volatile asset classes, a stop loss order is useful because rapid price slides can trigger panic. It therefore allows you the luxury of knowing that you have an automatic defense mechanism against such events.
3. It is easy to implement a Stop Loss order. A trader, for instance, may attach a stop-loss to a limit order before the order is executed. Spread and other fees only kick in once the trade is executed.
The downside is that temporary slides, commonly known as flash crashes, may trigger a stop-loss prematurely. This is especially a downside when prices rebound. Besides, a stop-loss order may not protect you from excess market volatility thereby limiting losses.
You might come across the phrase trailing stop-loss when looking at stop-loss orders. This is a stop-loss set in terms of points (pips) level above or below the market price. The trailing stop price is adjusted as the price fluctuates.
2. Take Profit Orders
Take profit is another popular order in risk management. To understand it best, it is better to illustrate its use in contrast to a stop loss.
In a stop loss, the trader sets a maximum loss limit. If the price slides below that limit, the position gets closed automatically. On the other hand, a take profits order allows a trader to set a profit margin at which the position gets automatically closed. It works as a maximum profit ceiling. A trader automatically “takes the profit” at this point because that is their stated goal.
To borrow a casino analogy, it is similar to cashing your chips when you have a winning hand. You may very well end up winning more that night, or start losing. Instead, you decide to settle for the profit you have made in the trade.
If the price does not reach the take profits limit, the position remains open. Therefore, the take profit price should be rational and achievable based on prevailing market sentiment. Similarly, it shouldn’t be too low so as to limit your profitability.
Once your take profit price is reached, the position automatically closes.
A take profit works in the exact opposite manner that a stop-loss does. They are like two sides of a coin.
Advantages of Take Profit Orders
1. Like stop loss, take profit inserts more rationality into decision making. A trader uses objective analysis to decide when to take profits rather than keeping their positions open for too long hoping for more.
2. In a rising market, it can provide a target for a trader to collect their wins. Take profits ensure that a trader can have a target price without tracking the market constantly to close their position.
The downside is that in a rapidly rising market, Take Profit orders can limit your potential. A Take Profit order closes your position and prevents you from continual exposure. In the volatile realm of crypto CFDs however, this tool can work to your advantage.
To Wrap It Up
Risk management is indispensable for any trader who wants to be successful in financial markets. At CryptoAltum, we emphasize that there are no substitutes for preparation and caution if you want to be successful in this field. There are covers already. CryptoAltum safely secures traders’ coins through cold storage and other measures. With the bases covered, it is the onus of the trader to do his/her best to maximize returns by using available tools.
Stop-loss and take profit orders are useful for managing risks and should be blended in any trading strategy. In the volatile world of cryptocurrencies, these limits arguably come in handy more than most other areas. Setting such limits is not only necessary but also useful to protect and grow your investments.
The two work in opposite ways but have a complementary effect. Therefore, prudent traders should master the workings of these limits to improve their overall risk management skills.
(Originally posted on https://cryptoaltum.com/en/two-ways-of-minimizing-risks-when-trading-crypto-cfds)