- Crypto is famous (and notorious) for volatility and dramatic price swings
- Traders need to keep emotions and impulses in check when trading this new breed of assets
The Risks of Crypto Trading
Cryptocurrency draws interest for its innovative technology, decentralization, and unregulated status that set it apart from all other trading assets. As with other speculative assets, such as tech stocks, traders are excited by the possibility of dramatic growth just around the corner and scramble to find the next hottest prospect before it breaks out. And when we consider the speed at which the crypto space has expanded, this is understandable. Even in April 2017, one Bitcoin could be purchased for a little over $1,000; just over four years later, BTC price topped $68,000. Every trader asks themselves the question: “What if I’d been the buyer x years ago…?”
But this market carries risks like any other, as well as some that are unique to the cryptosphere. Before you open any trades, take a look at the things to avoid when trading crypto.
The Danger of Speculation
With great trading opportunities comes great risk. This is first thing any trader should grasp before they venture into the crypto market. Only in the crypto markets do we see assets explode in popularity virtually overnight and others slip into oblivion just as suddenly.
However, it is important to emphasize the speculative in these types of assets. Unlike assets such as commodities or bank stocks, speculative assets (particularly in the tech sector) are valued for their growth potential and volatility. This means that their popularity is dependent upon prevailing market sentiment of the time, and liable to fluctuation according to broader economic conditions.
We saw this exemplified in January of 2022. As the US Federal Reserve’s policy outlook became increasingly hawkish, traders shied away from speculative tech stocks and cryptocurrencies. The US government’s tapering of market stimulus, plans to raise interest rates, and strengthening of bond yields dampened speculative investment prospects and diverted traders to more stable value assets. Tech stocks plummeted, and crypto followed suit: the total market capitalization shrank from $3 trillion in November 2021 to just over $1.5 trillion in January 2022.
The takeaway is that although crypto is a decentralized and deregulated novelty, its market does not exist in a vacuum. Crypto markets can be affected by the same factors that shape the other financial markets, so traders would do well to keep an eye on broader economic fundamentals.
Avoid underestimating the speculative nature of the crypto market as a whole!
FOMO and FUD
“Fear of missing out” is a very common pitfall for crypto traders. The crypto market’s incredible growth over the past decade has attracted flocks of people desperate to cash in before prices rise, leading to impatient, flippant, and careless trading.
Naturally, the internet only adds fuel to the fire. From celebrity influencers (see Elon Musk, Jack Dorsey), to self-proclaimed CryptoArmies, the internet bombards traders with tips on the next Bitcoin challengers and promises of imminent, exponential profit. The crypto crowds are certainly dynamic and enthusiastic, and it’s fun to become immersed in a trading community. However, you should hesitate before following with your money!
This is easier said than done in an environment that thrives on hype and drama. FUD, short for Fear, Uncertainty, and Doubt, refers to the way in which media and the internet stir up emotional investment in the markets and sow the seeds of negativity. This leads to traders panic-buying or selling on little more than rumour and can, more broadly, undermine faith in crypto as a whole. For Governments or institutions wary of DeFi, it is often in their interests to emphasize the risks of money laundering or deregulation to discredit cryptocurrencies.
The key to tackling FOMO and FUD is known as DYOR, short for “do your own research”. Instead of rushing into positions on the advice of online, traders should undertake their own analysis to make sure their trading instincts come from reason rather than emotion. Drawing information from diverse sources (and not just Twitter) allows you to keep their eye on the broader market picture rather following individual opinions.
Avoid being swayed by your emotions and entering the markets on impulse!
In addition to the risks of speculation attached to the market in general, crypto is capable of providing price roller coasters day-to-day and even hour-to-hour. The nascent industry is constantly evolving and the market is yet to establish a firm concept of market value. On the one hand, there are thousands of competing coins flooding into the market; on the other, governments are trying to figure out how to regulate and control DeFi.
Even crypto enthusiasts will admit there is uncertainty surrounding the future of crypto and so prices have a tendency to lurch with the slightest stimulation. Traders should take this into account whenever approaching the markets and ensure that their strategy suits their choice of coins or to crypto in general. High volatility does not suit every trader and beginner traders especially should be wary of focusing exclusively on crypto until they are confident in their risk management.
Avoid being caught out by high volatility!
Failing to diversify is risky in any market; with crypto volatility added to the mix, it’s a recipe for disappointment. Luckily, traders literally have thousands of cryptos to choose from, including stablecoins, value coins, or tokens. The temptation is to pile capital into the latest hot prospect (see FOMO above), but you should bear in mind the old trading mantra of not committing more than 1-2% of your capital per trade.
Fiat currencies all serve similar purposes and only vary in their relative strengths to each other. In contrast, different cryptos are capable of fulfilling completely different capabilities. Each crypto fights to justify its place in the market, whether as a store of value (Bitcoin), blockchain currency (Ether), or stablecoin (USDT). Thousands of cryptocurrencies have already disappeared from the market as they proved to be unviable. And it’s likely that plenty more will drop out of contention as the industry finds its footing. With this in mind, it’s better to spread trading exposure across multiple assets in order to “hedge” against potential failures.
Avoid putting all your eggs in one basket and restricting your market exposure!
With all the above risks to consider, careful risk management is absolutely crucial for handling cryptocurrencies. This encompasses everything from DYOR, to planning your trades, diversifying your exposure, and remembering to anticipate high volatility.
In practical terms, it’s worth using a demo account to try and test a strategy before entering the live markets. Traders can familiarize themselves with their chosen cryptos and practice placing trades without realizing any real loss. In addition, you can learn how to use leverage to profit on volatility.
On the live markets, the universal principles of risk management apply:
- Stop losses and limit orders should be used to contain risk
- Traders should never commit more than they can afford
- Leverage should be kept manageable in order to keep margin healthy
- Failing to monitor open trades can lead to nasty surprises
- Traders can steer clear of volatile assets until confident in their strategy.
Avoid neglecting basic risk management in this novel market!
Intimidating as it may seem, you should not shy away from the particular risks of trading crypto. You can gain exposure to cutting-edge fintech developments, and digital assets are also unique in their variety and ambition. Crypto is both prized and feared for its extreme volatility; you must respect the risks if you are to reap their rewards. Above all, try your hardest to keep your emotions out of trading.
What Are The Risks Of Crypto Trading?
Trading crypto is highly speculative compared to traditional assets, and traders can be caught out by volatile price movements and reversals. In addition, the internet often cultivates emotional bias in the crypto markets by contributing to FOMO and FUD.
How Do I Avoid The Risks Of Crypto Trading?
As in any market, risk management is vital. Avoid trading on emotion, balance your crypto exposure, and always do your own research. When placing trades, never neglect to place stop-losses and take-profits to contain your position.
Why Is Crypto Trading Risky?
Compared to other markets, crypto is immature and unpredictable. There is a lot of uncertainty about the future of individual cryptocurrencies and the industry as a whole, so the market is characterized by major volatility. Over time, prices may settle down as regulatory issues are resolved and the technology becomes more mainstream.