7 Best Risk Management Strategies For Trading Crypto
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Crypto’s price volatility creates outstanding trading opportunities. However, those ups and downs — along with additional ways to trade that aren’t available in traditional investments — also bring risks. To keep your profits, it’s important to implement crypto risk management strategies that help protect your capital.
Crypto trading risk management centers on several key areas. These include basics like using reputable crypto wallets and exchanges and diversifying your portfolio. You’ll also want to examine ways to prevent losses from getting out of hand and prevent emotions from taking the wheel.
In this guide, we detail seven ways to protect your downside, which can ultimately help you maximize your earning potential from crypto trading.
7 Ways to Manage Risk When Trading Crypto
Any crypto risk management system has to be tailored to the way you trade. For instance, leverage traders have risks to consider that you won’t need to worry about if you only make non-leveraged spot market trades. In the sections below, we’ll discuss the key focus areas for risk management in crypto trading. Compare each against your trading style to customize your crypto asset risk management strategy.
Let’s start with the basics: choosing reputable exchanges and crypto wallet apps.
1) Use Reputable Wallets and Exchanges
Unlike traditional finance, crypto trading comes with relatively few safeguards. With little regulation or oversight, it’s important to choose providers wisely.
You’ll need to research wallet apps and exchanges before you make your first trade. First, let’s discuss what can go wrong and why choosing reputable crypto providers becomes essential.
Choose a Reputable Crypto Exchange
Crypto exchanges provide an on-and-offramp for fiat to crypto trades. For example, you can use Coinbase to buy Bitcoin (BTC) using USD. Coinbase is the world’s largest publicly traded exchange, and many consider it to be among the safest. Coinbase also acts as a custodian for several Bitcoin and Ethereum ETFs (exchange-traded funds).
While Coinbase is considered one of the safer options, some other well-known exchanges have closed or paused withdrawals without notice. 2022 saw the failure of the FTX exchange, a then up-and-coming platform that reached public notoriety with its Super Bowl ads. The FTX platform paused withdrawals and then declared bankruptcy, forcing those with crypto held on the exchange to wait in line to recover their funds.
When choosing an exchange, look at their history, whether they have ever been hacked, how they store clients’ fiat and crypto assets, security features, and user reviews.
Select a Proven Crypto Wallet
The woes faced by FTX customers and customers of other failed exchanges can often be avoided by taking your crypto off the exchange between trades.
Exchanges offer custodial crypto wallets, meaning the exchange holds the private keys for the wallet. As a safer alternative, you can choose a self-custody wallet and transfer your digital assets to that wallet instead. With a self-custody wallet, you hold the private keys to the wallet.
Look for a well-tested wallet app that supports the cryptocurrency you’re trading. For example, MetaMask is a popular choice for Ethereum and Ethereum Layer 2 networks like Base. Many Bitcoin investors use Electrum or Sparrow, two powerful Bitcoin-only wallet apps.
Consider a hardware wallet such as Ledger or Trezor for larger crypto balances. Both wallet brands date back to 2014 and are among the most trusted multi-chain options. Hardware wallets generate and store the wallet’s private keys offline, making them a safer choice.
2) Appropriate Position Sizing
One of the most common disclaimers in crypto trading is, “Never invest more than you can afford to lose.” That timeless maxim also applies to individual trades. Consider the volatility of the specific cryptocurrency you’re trading and choose a trade amount appropriate for your budget and for the potential risk.
For example, a $1,000 Bitcoin purchase likely carries less risk than a $1,000 investment in a newly launched coin for an unproven network. Let’s say that Bitcoin Nouveau launches as a new fork of Bitcoin’s code. The new (fictional) network takes a novel approach to Bitcoin mining difficulty and reduces block times to 30 seconds versus 10 minutes for Bitcoin.
How much should you invest in Bitcoin Nouveau? Consider the volatility of newer and unproven cryptocurrencies and invest accordingly. In this case, a small investment makes a safer choice, assuming you think it’s wise to invest at all. In this fictional example, Bitcoin Nouveau may go to zero, which is unlikely to happen with Bitcoin itself. Perhaps a smaller investment (or none at all) is more prudent.
On the other hand, small investments in Bitcoin during its early years created millionaires worldwide. A small investment in a promising crypto project can yield massive returns. A $1,000 investment in Bitcoin in 2014 would be worth more than $77,000 in 2024. However, balancing the opportunity from any trade with the potential risk of significant losses is essential to crypto risk management.
3) Portfolio Diversification
Diversifying simply means not putting all your eggs in one basket. Cryptocurrency prices often move in sympathy with Bitcoin’s price, but large divergences are also possible. The chart below shows that during a one-month timespan, BTC is up 4.15%, whereas Ethereum is down 14.13%. If you only held Ethereum, your crypto portfolio would be down by 14%. Holding both Bitcoin and Ethereum in equal amounts would limit your paper losses dramatically.
Diversification becomes even more important when buying cryptocurrencies with smaller markets. Small-cap cryptos, meaning those with a comparatively low market capitalization or fully diluted market cap can see much more dramatic price moves. You should assess always your risk tolerance when choosing to add any asset to your portfolio.
Many crypto investors choose a diversified portfolio of blue-chip cryptocurrencies. Using diversified holdings as a base allows more flexibility to trade small-cap coins or even meme coins without gambling the entire portfolio down to dust.
4) Stop-Loss and Take-Profit Orders
You’ll never go broke taking a profit. This adage from stock trading holds true for crypto investing, and keeping losses to a minimum is equally important. Fortunately, most crypto exchanges offer ways to automatically take profits or exit a position before losses mount.
To use these tools, you’ll need to use an advanced trading platform in most cases. For example, Coinbase offers Coinbase Advanced, and the Kraken crypto exchange offers Kraken Pro. Let’s look at both stop-loss orders and take-profit orders to see how they work.
Stop-Loss Orders
Like it says on the tin, a stop-loss order can close your position when it reaches a level you set for the order. Let’s say you put in a buy for Bitcoin at $55,000 because your crypto trading indicators suggest the buying momentum will continue.
However, indicators aren’t always perfect, and news can instantly change the market direction. You put in a stop-loss order for $50,000. This limits your potential loss to less than 10%, preventing you from losing more if the market sells off. Your order will automatically sell your BTC if the market drops that low. If the order isn’t triggered, your stop-loss remains unused.
Many advanced trading platforms, such as Binance, also offer trailing stops. A trailing stop adjusts its price as the market moves upward. This type of order lets you ride the market gains while protecting your downside on pullbacks.
Take-Profit Orders
A take-profit order works similarly by automatically closing your position at a profitable price you set. If you set your order to execute when Bitcoin reaches $60,000, the exchange adds this order to the order book. The order adds liquidity to the book but won’t execute until that target is reached.
Many traders bracket their initial trade with both stop-loss and take-profit orders as an effective crypto risk management strategy.
5) Risk/Reward Ratio
You can set your stop-loss and take-profit orders using a risk-reward ratio. For example, if you used a 2:1 ratio, your order structure might look like this:
- BTC entry price: $50,000
- BTC take profit price: $51,000
- BTC stop-loss price: $49,500
In this example, your potential upside is twice as much as your potential loss. Using a risk-reward ratio can help protect your trading capital. However, be aware that stop-losses may be more likely to trigger with tight stops or more trading volatility. There’s a possibility that the market takes out your stop loss (locking in the loss) only to reverse and rebound to a higher price.
6) Manage Emotions and Stick to Your Plan
Most of the crypto risk management strategies discussed in this guide aim to bring more discipline to trading. Another benefit is that they can help remove emotion from your trading. A common mistake for newer — and even more experienced traders — is to react to the chart movements emotionally.
Often, we chase green candles (buying the top) or sell in fear during a falling crypto market, perhaps selling at the bottom.
Revisiting your reason to make a trade is healthy. However, letting fear of missing out (FOMO) or panic selling rule your trades seldom ends well.
The chart above shows a massive selloff for BTC starting in late July 2024. After reaching resistance at $70,000, BTC sold off sharply. However, the selloff had only begun. By August 5th, BTC cratered to less than $50,000. Many sold at or near the bottom. Others were liquidated when using leveraged trades. We’ll discuss leverage in the next section.
Fear ruled trading decisions on that day. However, the time to sell was much earlier. Sales that occurred below $60,000 lost money unnecessarily. Within a few days, BTC traded above $60,000 again.
A trailing stop-loss order could have saved the day in this situation. Suppose you had a trailing stop loss set for 10% below the market price. Based on the $70,000 high, the order would have exited your position at $63,000. You could have then used the proceeds to buy it back at $50,000, buying more BTC than you held previously.
7) Avoid Reckless Use of Leverage
Leverage refers to borrowing against collateral assets to control a larger trading position. For example, with 5x leverage, you can control $500 worth of BTC with $100 worth of collateral, also known as margin.
Using leverage allows you to multiply your profits. A $50 profit without leverage becomes a $250 profit at 5x leverage. Similarly, a $10 profit without leverage becomes $200 in gains at 20x. Many crypto exchanges support trades with up to 50x or even 100x leverage. The profit opportunities can be tempting.
However, the outsized gains can also become quick losses. Leverage works both ways. A 5% dip in price at 20x leverage will wipe out your margin. At 100x, a mere 1% loss forces a liquidation. In most cases, the exchange will sell your collateral before reaching these levels, locking in the loss and collecting trading fees from the remainder.
Unlike buy-and-hold strategies, leverage trades often can’t survive market dips. With higher leverage, the risk of liquidation increases, amplifying small market moves into massive losses that threaten the entire trade amount.
What is Risk Management in Crypto Trading?
Crypto risk management refers to building strategies around your trading style that reduce the chance of losses or limit your losses to a manageable level. The goal is to protect trading capital so you can continue trading and working toward your portfolio objectives.
Crypto trading risk management techniques can range from simple diversification to straddling trades with stop-loss and take-profit orders. The former limits losses, while the latter locks in a profit when the trade value reaches a level you choose.
One study suggests that up to 97% of day traders lose money. While that dismal statistic might cause would-be traders to lose heart, crypto trading risk management can help reduce the downside and keep you in the game longer, possibly long enough to score outsized returns.
However, without caution and discipline, you might see your investment capital halved in minutes or over the span of a few days. Continuing without the safety net of effective risk management could spell doom for your portfolio. The good news is that crypto trading risk management doesn’t have to be complicated. Most spot market traders can utilize just a few of the strategies detailed earlier to reduce their risk significantly. As your trading strategy evolves, you can consider more techniques, such as defining strict leverage limits.
What Are The Biggest Risks When Trading Crypto?
By some measures, crypto brings bigger inherent risks compared to trading in traditional markets like stocks. Crypto sees more market volatility. Crypto storage also brings unique risks, as do blockchain transactions. Let’s touch on some of the biggest concerns for crypto traders.
Extreme Price Volatility
The 1987 stock market crash, known as Black Monday, caused the Dow Jones Industrial Average to lose more than 23% of its value in a single day. To this day, the crash reminds traders of what can happen to trading capital when everyone rushes for the exit.
However, those types of drawdowns are much more common in crypto. ETH fell more than 25% on an otherwise quiet Sunday evening in August 2024. Bitcoin sold off as well, but to a lesser extent. Although many cryptocurrencies provide an alternative to traditional currencies, their price value in traditional currencies can be erratic.
Strategies like diversification and using stop-loss and take-profit orders can help protect your portfolio from crypto’s volatility.
Hacks, Theft, and Exploits
Unlike traditional finance markets, cryptocurrency offers few safeguards, and users must brush up on crypto security best practices to stay safe. According to estimates, crypto hacking thefts doubled in the first half of 2024 compared to 2023.
Cryptocurrencies, wallet apps, and exchanges themselves are all built with computer code. Hacks, bugs, and exploits remain a risk. To reduce your risk, consider using well-funded exchanges that focus on security. When choosing wallet apps, favor those with a proven track record and a history of third-party audits.
Emotional and Psychological Risks
Crypto’s price swings can take a psychological toll. Trading often leads to stress. Price direction can change instantly, turning a winning trade into a money loser — and then change direction again. One study measured the prevalence of anxiety among day traders, finding that nearly 19% suffered severe or extreme anxiety.
Treat each trade like a business decision to remove the emotion from trading. Develop a plan and study the market before making a trade. Use crypto trading indicators to confirm your trading strategy.
Perhaps most importantly, have an exit strategy. Stress comes from not knowing what will happen to your money after you open the trade. Will you 10x your investment or lose it all? Planning an exit strategy, perhaps using take-profit and stop-loss orders, removes much of the anxiety. Using these types of orders to bracket your trade lets you get on with your day. You know the downside risk and can take profits automatically.
What Are The Riskiest Crypto Trading Strategies?
As with any form of trading, some crypto trading strategies bring more risk compared to others. For example, holding Bitcoin long-term is usually less risky than trading low-cap meme coins daily — although the right crypto day trading strategies can help mitigate risks here. Strategies that are well-matched to the market offer outstanding opportunities.
Let’s examine some of the riskier strategies. Traders more prone to anxiety may want to avoid these.
Margin Trading and Leverage
Margin and leverage go hand in hand. Leverage allows you to trade in larger amounts. For example, you can control $500 worth of a crypto asset with $100 using 5x leverage. This works by using margin, which refers to the collateral you offer for the trade. In this example, the margin is $100. You can think of it as a “margin of error,” meaning that your trade can lose up to $100.
Yes, you can lose your entire margin using leverage. Higher levels of leverage further increase the liquidity risk. This situation is much less likely when trading the spot market with no leverage.
Day Trading
Day trading refers to trading several times daily and closing all your positions on the same day. By contrast, long-term or swing trades can last days, weeks, or even months. Day trading often involves quick decisions that may not be well-researched.
By some estimates, up to 97% of day traders lose money, and most underperform the market. In many cases, buying and holding offers a safer strategy, using trailing stop-loss orders to protect your capital.
Initial Coin Offerings (ICOs)
One way of launching a new cryptocurrency token is through an ICO (initial coin offering). You might see these with different names, such as a presale. The attraction of ICOs centers on the outsized gains if the coin performs well when it reaches trading markets.
However, over 80% of the ICO launches during the 2018 ICO boom were scams. Some figures suggest that ICOs have a 10% success rate, meaning there’s a 90% chance of a loss. Arguably, this figure is higher because some may fall in value after launch.
Scalping and Arbitrage
Two additional risky ways to trade include scalping and arbitrage. Let’s look at each of these.
- Scalping: As the name suggests, scalping refers to taking a little profit off the top. Actively traded cryptocurrencies see daily price fluctuations. Scalping tries to capitalize on these small movements with multiple trades, taking a small profit each time. The risk comes in the losses. Small profits may not offer enough protection if the market moves against your trade in a big way.
- Arbitrage: Markets aren’t always in sync, creating opportunities to buy lower on one exchange to sell at a higher price elsewhere. The challenge is in timing. An exchange with a higher price for a given cryptocurrency may align with the broader market price before you can execute an arbitrage trade. Deposit waiting times are the primary culprit. You might wait as long as an hour for the required network confirmations before trading with deposited assets.
Conclusion
Crypto risk management is an essential part of trading. Without considering potential risks and planning ways to reduce your exposure, you could become another trading statistic.
Develop your own crypto risk management frameworks. Start with the basics, including choosing a reputable exchange and crypto wallet. Next, consider using stop-loss and take-profit orders to bracket your trade. If you use more advanced trading techniques, such as leverage, know the risks before you choose a trade amount. No matter how you trade, never invest more than you can afford to lose.
References
- Crypto’s string of bankruptcies (reuters.com)
- Here’s how much money you’d have if you invested $1,000 in bitcoin 10 years ago (cnbc.com)
- Attention Robinhood power users: Most day traders lose money (cnbc.com)
- Is This 1987 All Over Again? What’s Driving the Market Meltdown? (wsj.com)
- Crypto hacking thefts double to $1.4 bln in first half of 2024, researchers say (reuters.com)
- Anxiety and Stress among Day Traders in Saudi Arabia (nih.gov)
- Attention Robinhood power users: Most day traders lose money (cnbc.com)
Elena Bozhkova 
