We enter a period when cryptocurrency-related financial instruments can thrive and as a result, retail and institutional traders will have a lot more options available when it comes to getting involved in this industry. Although many prominent figures constantly suggest that any investor should have a few percentage points of the portfolio in cryptocurrencies, we should treat them differently.
A measurement of how much the price of an asset varies over time, volatility refers to the amount of uncertainty or risk in a particular financial asset. When dealing with cryptocurrencies, traders should know that they’ll have to face elevated volatility levels from time to time. If you are one of those that want to keep track of volatility levels, you have tools like the Bitcoin Volatility Index, which is used to track the BTC and LTC price volatility in US dollar terms.
Dealing with volatility also implies that we, as traders, adjust our trading strategies. The cryptocurrency market is still less liquid as compared to forex, stocks, commodities, and other traditional markets, the main reason why we see wild price variations in crypto. This is how cryptocurrency works and we must find a way to adapt. False breakout setups occur very often in the cryptocurrency market and used with-trend, it may result in some good trading opportunities.
There’s still a lot of unclarity in terms of regulation for cryptocurrencies. Governments around the world still did not manage to find common ground with regards to this issue, leaving the entire industry at risk. One of the main downsides has to do with the traditional exchange platforms, most of which do not follow any specific regulatory requirements.
This is the main reason why people and institutions are leaning towards derivative instruments based on cryptocurrencies. Trading platforms, futures contracts, and ETFs are financial instruments regulated by financial regulators and must comply with regulation depending on the country of operation.
In dealing with fiat cryptocurrency pairs, the value of the US Dollar, Euro, Pound, etc. may have an influence on our trading strategy. However, currency fluctuations are small, given that the forex market is the most liquid in the world. As a result, you’ll need to focus on a completely different set of fundamentals in dealing with cryptocurrency trading.
Whether it is cryptocurrency forks, system updates that improve a particular token, halving announcements, adoption news, regulation news for big cryptocurrency markets, or any other significant event which may impact the market or a particular token, are the fundamentals which you must monitor. That means you’ll also need to allocate some more time if you add cryptocurrencies to your portfolio, given that the correlation with other traditional assets is limited.
Some advanced knowledge on the blockchain technology will give an insight into the world of cryptocurrencies and could help you understand better and faster any new significant improvement in the industry.
Given that we will be dealing with higher volatility, our risk management model should also face some changes. There could be a debate on what percentage of your capital should you allocated for cryptocurrency trading. However, there’s no golden number and you should risk as much as you are comfortable with.
When it comes to your risk parameters, it also depends on your risk tolerance. If you are ok with facing greater losses occasionally in order to generate higher returns, you could risk between 5-10% on each trade. If you want to take a more conservative approach, risk less, 1% or 2%.
Secondly, you have to consider the reward to risk ratio, calculated by dividing the potential target with the defined stop loss. In the case of stocks, forex, and the traditional markets, a 2:1 reward to risk ratio is considered to be optimal. However, given that cryptocurrencies are more volatile, you should gun for a higher R/R, 3:1 or 4:1, given that prices fluctuate more.
The last component of your risk management model is the accuracy, of the percentage of winning trades. Although aiming for a 3:1 or 4:1 R/R will be able to compensate for some losses, you should make sure that you manage to keep accuracy above 50% on a constant basis. Be selective with the trading opportunities which you encounter.
People are being attracted by the cryptocurrency market because they believe higher volatility equals higher returns. They jump in with very high expectancy levels which, most of the time, won’t be met. Don’t raise the bar too high and instead have a lot expectancy level, even lower than the one you have for stocks.
The cryptocurrency market is still an uncertain terrain and you will be caught off by surprise many times. You probably already know that one of the main characteristics of a professional trader is that he always focuses on the process and not on the actual results (profits).