Résumé
Risk management is an essential part of responsible investing and trading. It can reduce the overall risk of your portfolio in various ways: for example, you can diversify your investments, hedge against financial events or implement simple stop-loss and take-profit orders.
Introduction
Reducing risk is a priority for many investors and traders. Even if your risk tolerance is high, you will still, in some way, measure the risk of your investments against the return. However, risk management is more complex than simply choosing whether or not to make risky trades or investments. A comprehensive set of risk management strategy tools are available, and many are suitable for beginners as well.
What is risk management?
Risk management involves predicting and identifying the financial risks associated with your investments in order to minimize them. Investors then use risk management strategies to help them manage their portfolio's risk exposure. A critical first step is to assess your current risk exposure and then strategize accordingly.
Risk management strategies are strategic plans and actions that traders and investors implement after identifying investment risks. These strategies reduce risk and can involve a wide range of financial activities, such as purchasing loss insurance and diversifying your portfolio across different asset classes.
In addition to active risk management practices, it is important to understand the basics of risk management planning. There are four key planning methods to consider before embarking on a specific risk management strategy, as the method you choose will guide your choice.
Four Key Methods for Risk Management Planning
Acceptance: deciding to take the risk of investing in an asset but not spending money to avoid it because the potential loss is not significant.
Transfer: transfer of the risk of an investment to a third party for a cost.
Avoidance: Do not invest in an asset presenting a potential risk.
Reduction: reduce the financial consequences of a risky investment by diversifying your portfolio. This can be done within the same asset class or even across other sectors and assets.
Why is a risk management strategy important for cryptocurrencies?
It is common for cryptocurrency, as an asset class, to be one of the high-risk investments available to the average investor. Prices have proven to be volatile, projects can crash overnight, and the technology behind blockchain can be difficult for newcomers to understand.
With the rapid evolution of crypto, it is imperative to use sound risk management practices and strategies to reduce your exposure to potential risks. It is also an essential step in becoming a responsible and profitable trader.
Read on to discover five risk management strategies that can benefit your crypto portfolio.
Strategy #1: Take into account the 1% rule
The 1% rule is a simple risk management strategy that involves risking no more than 1% of your total capital on any investment or trade. If you have $10,000 to invest and you want to respect the 1% rule, there are several ways to do it.
One would be to buy $1,000 worth of bitcoin (BTC) and set a stop-loss or stop-limit order to sell at $9,900. Here you will reduce your losses to 1% of your total investment capital ($100).
You can also buy $100 worth of Ether (ETH) without setting a Stop-loss order, as you would only lose a maximum of 1% of your total capital if the ETH price hits 0. The Rule of 1s % does not dictate the size of your investments.
The 1% rule is especially important for crypto users due to market volatility. It's easy to become greedy, and some investors may put too much into a single investment and even suffer heavy losses while waiting for their luck to change.
Strategy #2: Set Stop-loss and Take-profit points
A Stop-loss order sets a predetermined price for an asset at which the position will be closed. The stop price is set below the current price and, when triggered, helps protect against further losses. A take-profit order works in reverse, setting a price at which you want to close your position and lock in a certain profit.
Stop-loss and Take profit orders help you manage your risk in two ways. First of all, they can be configured in advance and will run automatically. There is no need to be available 24/7, and your predefined orders will be triggered if prices are particularly volatile. It also allows you to set realistic limits for the losses and profits you can take.
It's best to set these boundaries in advance rather than in the moment. While it may be strange to consider take-profit orders as part of risk management, you should remember that the longer you wait to take your profits, the greater the risk that the market will decline.
Strategy #3: Diversification and hedging
Diversifying your portfolio is one of the most popular and fundamental tools for reducing your overall investment risk. A diversified portfolio will not be overly invested in any one asset or asset class, thereby reducing the risk of heavy losses from any one asset or asset class. For example, you can hold a variety of different currencies and tokens, as well as provide liquidity and participate in loans.
Hedging is a slightly more advanced strategy to protect gains or minimize losses by purchasing another asset. In general, these assets are inversely correlated. Diversification can be a type of hedging, but futures are probably the best-known example.
A futures contract allows you to set a price for an asset at a future date. For example, if you think the price of Bitcoin will fall, you decide to protect yourself against this risk and subscribe to a futures contract to sell BTC at $20,000 in three months. If the price of Bitcoin does indeed fall to $15,000 three months later, you will profit from your position on the futures contracts.
It is important to remember that futures contracts are financially settled, and you do not need to physically deliver the coins. In this case, your counterparty would pay you $5,000 (the difference between the spot price and the futures price), and you would have hedged yourself against the risk of the bitcoin price falling.
As mentioned, the crypto world is volatile. However, there are still opportunities for diversification within this asset class and hedging opportunities. Diversification in crypto is much more crucial than in more traditional financial markets with less volatility.
Strategy #4: Prepare an exit strategy
Having an exit strategy is a simple but effective method to minimize the risk of heavy losses. By sticking to a plan, you can take profits or reduce losses to a predetermined point.
Often, it's easy to want to continue making profits or believe too much in a cryptocurrency, even when prices are falling. Being manipulated by a trend, bulls or a trading community can also cloud your judgment.
One way to successfully implement an exit strategy is to use limit orders. You can set them to trigger automatically at your limit price, whether you want to take profits or set a maximum loss.
Strategy #5: Do Your Own Research (DYOR)
Do Your Own Research, or DYOR is an integral risk reduction strategy for any investor. In the age of the Internet, it's easier than ever to do your own research. Before investing in a token, currency, project or other asset, you should conduct due diligence. It is essential that you check essential information about a project, such as its white paper, business model, partnerships, roadmap, community and other fundamentals.
However, misinformation spreads quickly, and anyone can share their opinions as if they were proven facts. When conducting research, consider where you are getting your information and the context in which it is presented. The shilling is common currency, and projects or investors can spread false, biased or promotional news as if it were objective and factual.
To conclude
With these five risk management strategies, you have effective tools to reduce your portfolio risk. Even using simple methods that cover most areas will help you invest more responsibly. Of course it is also possible to create risk management plans with more advanced and in-depth strategies.
To learn more about the subject, refer to the following articles:
How to Manage Risk and Trade Responsibly | Binance Support
What is the risk/reward ratio and how to use it | Binance Academy
3 reasons why Binance Futures is traders' favorite hedging tool