In financial markets, along with profits will always be a risk. Risk is an important factor that investors as well as traders need to pay attention to as it will determine your success. In order to reduce the risk to the lowest level, you need to develop an appropriate risk management plan.
Cryptocurrency investments are profitable in the hundreds of percent, but are accompanied by high-risk volatility. So how to manage capital effectively when investing in cryptocurrencies to ensure the lowest investment rate with the lowest risk?
In the following article, Ola City will help you learn about risk management in the cryptocurrency market through the article below! Please follow up.
I. What is risk management?
In essence, risk management is all that involves evaluating and responding to possible risks. We are constantly managing risk throughout our lives from simple tasks such as driving a car or when making purchases of insurance programs. Most of us manage them unconsciously in our daily activities. However, when it comes to financial markets, risk assessment is a very important and meaningful job.
In economics, we can describe risk management as the framework that defines how a company or investor handles inherent financial risks for all types of business. For traders and investors, the framework can include the management of a variety of asset classes. Such as cryptocurrencies, Forex, commodities, stocks, indices and real estate.
There are many types of financial risk, which can be categorized in many different ways. This article provides an overview of the risk management process. It also presents a number of strategies that can help traders and investors minimize financial risk.
II. The importance of risk management
Risk management is a very important process because it helps users be ready to identify and deal with potential risks fully. Once the risk has been identified, then minimizing the risk becomes easy. In addition, risk management provides people with the basis to be able to make the right decisions that save money and protect their future.
In addition, risk management ensures high-priority risks are handled as actively as possible. Moreover, users will have the necessary information that they can use to make informed decisions and ensure that investment activity remains profitable.
III. Types of basic risks
The first step to managing business risk is to understand the different risks in life. Different types of risks to consider vary as well as risks that can fluctuate between businesses, so it’s important to be aware of all possible risks. There are many types of financial risk, categorized in many different ways.
1. Material risk
Physical risk is any type of potential risk that can cause physical harm. The most common example of this is infrastructure construction risk. Such risks may include fire risks such as faulty wiring or overloaded power strips..
2. Human risk
Human risk is fairly simple and includes any potential risks that occur to yourself. There are many risks people need to consider, including illness, trauma, substance abuse.
3. Technology risk
Technology risks associated with the different devices you use. When your technology or device isn’t working, this can significantly prevent or eliminate your ability to do the job. Some common technological risks are outdated technology, power outages, Wi-Fi outages, faulty phones.
4. Strategic risk
This is a risk that investors as well as traders in the crypto market are susceptible to. Strategic risks relate to the various investment plans that organizations implement. For example, you decide to invest in crypto projects that promise high interest rates but the credibility has not been validated so it is easy to be scammed.
IV. Risk management steps
Typically, the risk management process consists of five steps: setting goals, identifying risks, assessing risks, identifying responses, and monitoring. However, depending on the context, these steps can vary significantly.
- Step 1: Set a goal
The first step is to determine what your main goals are. It usually involves your ability and level of personal risk tolerance. In other words, how much risk you’re willing to take to achieve your goals.
- Step 2: Identify the risk
The second step involves detecting and identifying what the potential risks are. It aims to reveal all kinds of events that can have a negative impact. In a business environment, this step can also provide insightful information that is not directly related to financial risk.
- Step 3: Risk assessment
After identifying the risks, the next step is to assess their expected frequency and severity. The risks are then ranked by severity. This facilitates a timely and appropriate response when an incident occurs.
- Step 4: Identify the answer
The fourth step involves identifying the responses to each type of risk, according to their importance. It establishes what action is taken in the event of an adverse event occurring.
- Step 5: Monitor
The final step of a risk management strategy is to track the effectiveness of that strategy in response to events. This often requires continuous data collection and analysis.
V. Managing financial risks in the cryptocurrency market
There are several reasons why a strategy or a trading setup may not be successful.
For example, a trader may lose money because the market goes against their long/short position or because when the market corrects they panic and eventually sell out out of fear. Emotional reactions often cause traders to abandon their original strategy. This is especially noticeable in bear markets and speculative periods.
In financial markets, most people agree that having a proper risk management strategy contributes to their success. In fact, this can be as simple as placing a Cut Sl or Take Profit order.
A strong trading strategy must provide a clear range of possible actions. This means that traders need to be best prepared to deal with all kinds of situations. However, as mentioned, there are many ways to manage risk. It is best that your strategies should be constantly revised and adjusted to suit the cryptocurrency market.
Here are a few examples of financial risks in the crypto market, along with a brief description of how people can minimize them to the lowest level.
- Market risk
It can be minimized by placing an SL Stop-loss order on each trade so that positions are automatically closed before incursions of larger losses.
- Liquidity risk
Can be minimized by choosing to trade on markets, high-volume assets. Typically, assets with a high market capitalization are generally more liquid.
- Credit risk
Can be minimized by trading through a trusted exchange so that borrowers and lenders (or buyers and sellers) don’t need to authenticate each other too much.
- Operational risk
Investors can minimize operational risk by diversifying their portfolios, preventing the unique risk that comes from a given project. They may also do some research to find the project or team behind it that has little operational problems.
- System risk
It can also be minimized by diversifying portfolios. But in this case, diversification should involve projects with distinct differences or companies from different industries. It is better that the things that you invest in should have a very low correlation with each other.
VI. Summary of 05 risk management methods in crypto
1. Acknowledge the risk
Crypto trading has a deep connection to the term “risk-reward.” The greater the risk, the higher the potential profit. But it’s not that simple. In the broad and volatile market, a multitude of factors can influence trends and price changes. Sometimes changes take place despite all the data, and the recommendation for analysis indicates the opposite direction. Even the most experienced traders may fail to predict market movements.
This brings us to the first step of risk management: Accept when risk occurs. Small losses are part of a long-term victory. What is important is the ability to accept these losses. When you fully take the risks, it will have a profound impact on your final performance.
However, learning to really take risks in any given thing is difficult, but it will be even more difficult for traders, especially when considering the times when they are at stake. Admitting we’re making mistakes and losing money is definitely worth avoiding. But as traders, we are faced with both of these possibilities almost every moment when we are in a trade.
Learn to love your losses, acknowledge that they’re part of your job, and you need to convince yourself that accepting “Planned” losses is a healthy behavior that doesn’t hurt your portfolio in the long run.
2. Risk sharing
During the investment or trading process, you will have the opportunity to have constant contact with other traders. You should share ways to prevent and control your risk with everyone. In addition, you can also participate in group chats, forums,… of the crypto community to share risk management experiences.
This will theoretically not do much. In fact, when you enthusiastically share with other traders, there will be more experienced traders who share with you what they have been through. Maybe it will be a big lesson for you to find a way to prevent them.
3. Transfer risk to a trusted place
For margin traders using leverage, when you achieve a certain level of profit, you should set aside a portion of them as an insurance fund in case of risk. Of course, they should only be used when absolutely necessary and this money should be spent in a reasonable, prudent manner.
For long-term crypto investors, in addition to hoarding a spare profit yourself, you can also look to insurance projects. It’s basically like buying life insurance for yourself in real life.
4. Prevent and minimize losses from risk
Of course, even if you are prepared to face the risk, the most important way is to minimize the damage it causes. Because removing the whole thing is almost impossible. To prevent and minimize losses, you can refer to the following 4 ways:
- Don’t buy a lot when you enter the market
For those new to financial markets, especially volatile markets such as cryptocurrencies, namely Bitcoin, caution and certainty are needed. Because when starting a new field, anyone can make mistakes or fall into the pitfalls of old scammers. And even if you’re confident of having enough experience, you can’t predict exactly how the market will play out.
Most investors are advised to start with small amounts of money. In fact, there are many new traders who use a large amount of money to invest in the initial investment and then burn the account. So start trading in small quantities, formulating your strategy in a way that suits you to minimize efficiency in the investment process.
- Always set a stop loss
For any cryptocurrency that is not in the medium/long-term portfolio, always set a stop loss. This is the principle to minimize the trader’s losses. But more importantly, with a stop loss, traders force themselves to decide on acceptable losses and learn to trade in principle.
- Portfolio diversification
Diversifying your portfolio will minimize the possibility of losses as Bitcoin plummets and drags down the market, and investments in other assets can save you from the risk of “burning your account.”
To diversify your portfolio, you can choose to combine your investment with other asset classes such as stocks, indices, commodities, forex,… By diversifying with assets in the same market (e.g. ETH, XRP) will be at systemic risk.
4. Choose a reliable source of information
Sources of information are quite important, they can make you subjective or lose your temper. For those who are new to investment should note, choose a reputable and quality information source.
Some reliable sites such as: Messari, CoinDesk, CoinTelegraph, CryptoCoinsNews, Bloomberg, Forbes, CNBC, Investing.com, Investing.vn,…
5. Limit exposure to FOMO-inducing activity
FOMO (Fear of Missing Out) is a fear or a fear of missing an opportunity. The most common example of Fomo action is in the field of coin trading. When the coin is on the verge of short-term gains, victims of this syndrome will have the thought of owning those coins immediately in order to make a profit quickly.
Such thinking causes them to make decisions that are too hasly, irrational when they do not have time to learn, calculate carefully and will easily lead to unpredictable consequences. A one-off result, good or bad, will affect how you trade later.
So sometimes doing nothing, i.e. not being exposed to fomo activities is also a way to lower your risk level. Referring to the most fomo moment of the crypto market is definitely the ICO in 2017, a crypto investment craze when the house “wins that coin”. Greed pervades the whole market. BTC can’t stay out of that cycle.
There are days when BTC jumps $1,000 in an hour, even in just a few minutes. A lot of people have changed their lives thanks to fomo, but the number of people “swinging” is not less likely to buy ETH at $ 1,400 / 1ETH or XRP for $ 3, but more than 3 years later, the price of BTC has broken the old peak and ETH, XRP is still “far from the homeland”.
The above story is a very typical case, when the market is in a situation that you cannot predict or you do not have any specific plans, do not do anything to preserve what you have. You may miss out on a small portion of the profits, but you may also avoid huge risks in this market.
Before you open a trading position or allocate capital to a portfolio, traders and investors should consider creating an appropriate risk management strategy. However, it is important to note that there is no way to completely avoid financial risk that we can only reduce it. The risk management process aims to assess the risk/reward ratio so that the most favorable positions can be prioritized.
I hope the article provides useful information to you. Don’t forget to follow Ola City’s next articles to update your useful knowledge about cryptocurrencies!
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