What is stop-loss in crypto trading? How to use it?

May 2, 2021

Reading Time: 5 minutes

With the cryptocurrency market cap crossing $2 trillion over the weeks, more and more people are jumping in on the bandwagon and trying out cryptocurrency trading. While cryptocurrency trading shares most of the same fundamentals of conventional trading, the medium can be extremely volatile and needs extensive knowledge of the field.

That is why before jumping into cryptocurrency trading, you need to have solid fundamentals and extensive knowledge of the assets and the technology behind them to succeed. In this article, we’ll be dissecting a common strategy or trading tool called stop losses. We’ll discuss how stop losses are used in conventional trading and see how it works in the cryptocurrency market.

What is Stop Loss?

Stop-loss is a trading tool commonly used in conventional trading where traders can limit the maximum loss of their trades by liquidating their assets once the price reaches a certain value. This whole procedure is usually automated leveraging sophisticated tools that are widely accessible on the market.

Interestingly, there are various types of stop-loss strategies that are being utilized in different scenarios with respect to the situation of the cryptocurrency market. While it can be difficult to avoid losses, especially in a volatile market setting; however, a solid stop-loss strategy can drastically mitigate or control those losses by a fair margin. Stop-loss can be an exceptional tool for upcoming and budding traders like yourself.

When are Stop loss strategies used?

Interestingly, the stop loss strategy is engineered for traditional markets, which aren’t as volatile and unpredictable as the cryptocurrency market. In standard markets, for example, if you approach a spot that isn’t doing well, the stop-loss order would be activated until the price hits a predetermined level.

Normally, conventional traders calculate their risk and determine how much they’re willing to lose on an asset in case the asset doesn’t go as planned. Stop losses can be great when markets are less volatile, and the price doesn’t fluctuate as much. Traders can pull out of a trade and re-evaluate their strategies before going back in.

But what if the markets are volatile and it doesn’t give you enough room to re-evaluate your strategy and get back in?

Stop Loss: A disaster waiting to happen

It is completely possible for the price of an asset to swing dramatically in competitive markets such as the cryptocurrency sector. As you know, we can use Bitcoin and other leading cryptocurrencies as an example. It is not common for the leading cryptocurrency assets to experience price drops exceeding 5% and recover in a few moments.

Remember, stop-loss orders today are automated. Considering the volatility of the market, it is plausible that you are prone to unwarranted stop-loss orders. Moreover, you’re more prone to market manipulation in a volatile market than in the cryptocurrency market.

Case in point:

Bitcoin capped at an all-time high of $64,000 on April 14 and dropped to $55,000 in under one week.

In this situation, executing a stop-loss order can be disastrous, considering it is inevitable Bitcoin rallies back to its original value.

Stop Loss Types

So, what should upcoming and budding traders do to control their losses? The case mentioned above clearly doesn’t mean that you refrain from using Stop losses indefinitely. Many different types of stop losses are engineered for unique situations. The case mentioned above was just a realistic view of what could happen if you dive into the cryptocurrency market without updating or adapting your fundamentals to the market situation.

Here are some of the stop-loss types used by most traders

Full Stop loss

The Full stop-loss order liquidates all of your crypto assets when triggered. While this is useful in a stable market; however, it may not be as helpful for a volatile market.

Partial Stop loss

The Partial stop-loss order liquidates a portion of your crypto assets when triggered. Now, this strategy can be an amazing tool for the cryptocurrency market. One of the most important things to do before making any major investment decisions is to spread the risk over many different types of asset classes. So, we encourage you to diversify your portfolio when trading cryptocurrencies.

Moving on, the partial stop loss can be an exceptional tool for volatile market conditions to ensure you still have some assets remaining if the price drops. Although, it may leave you with unwanted assets, and you could potentially remain at a loss. This is why it is important you diversify your portfolio.

Trailing stop loss

Interestingly, this is one of the more sophisticated tools that are catered towards volatile markets like the cryptocurrency market. With the trailing stop-loss order, you can set a trailing distance: the difference between the current price and the stop loss value.

Suppose the price of the cryptocurrency rises, the stop loss value will rise with it; however, when the price of the asset drops, the stop loss value will not rise and be triggered when the price reaches the specified value.

This strategy can be extremely beneficial for capping your maximum loss. Moreover, you don’t have to reset your stop-loss target every time the price goes up.

Bottomline

The Stop loss strategy can be misinterpreted for upcoming traders since it’s often seen as a failsafe instead of a calculated insurance policy that you should use in correspondence to the occasion. The Stop-loss tool can be used to its maximum potential by experienced traders to save time and money.

However, consistently using it as a failsafe can be disastrous for your portfolio as an upcoming trader. Although stop losses are engineered to mitigate and control the damage, you must calculate your risk-reward ratio and use it very carefully.

Ultimately, the stop-loss order is just a tool that should be used very carefully and needs careful evaluation of the market.

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