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Introduction to Risk Management in Cryptocurrency Trading

Table of Contents

Most of the newbie investors assume that investing more or investing at a specific time in cryptocurrencies may lead to more profit. While some of them do succeed in some cases, it is definitely a wrong assumption to begin with. Apart from the size and time of investments, acknowledging the factors that may drown your investment is as crucial as anything when it comes to investing in cryptocurrencies. These factors are known as ‘Risks’, and in this module, we will learn what kind of risks are involved in cryptocurrency investments, how to identify them, and how you can avert or reduce them.

What is Risk and Risk Management?

Think of adventure sports. You go for an adventure sport for the rush it brings you. But what is it in adventure sports that brings you the rush? It’s the risk. The riskier the sport, the more the adrenaline rush. If you just sit at home and take no risk, there is no rush, and hence, no return. On the other hand, you go skydiving, even when you are skeptical about whether or not the parachute will open. But you take the risk anyway by throwing yourself off the plane to have the best experience of your life. Same goes for asset trading. The more risk you take, the higher are your chances of making a profit. You risk nothing by investing in a stock or cryptocurrency that has been stagnant for years, you get no returns.
But then, would you make the jump until you are sure about the equipment quality? You most certainly won’t if the equipment and gears looked rickety. Bad quality equipment poses a risk, but you manage the risk by making sure, from your end, that making the jump would indeed be safe. That is how you manage risk. Identifying a risky trade and not entering it is as good as making a profit. Apparently, ignoring risk management could have you end up hitting rock bottom, or simply put in financial terms, losing your investment. But then, even when you double checked that the equipment and gears were new and safe, you still know there is always a chance that something may go wrong. The point here is that you can never reduce the risk to 0%, no matter what kind of financial instrument you are investing in; you can only manage and reduce it.
Talking purely in terms of asset trading, risk can be described as the possibility of an investor incurring losses due to changes in the market. Some of the common risks associated with asset trading are recession, uncertainty, change in financial/monetary policies, natural disasters, political turbulence, etc.
Risk management practices are meant to reduce the severity of risk factors involved in an investment opportunity. Essentially, risk management translates to identification, analysis and mitigation of a risk to measure the degree of possible losses and proceeding with the investment decision as per one’s risk tolerance. Risk tolerance, in simple words, means how much loss can one tolerate in a failed trade. Whenever you invest, as an investor, your job is to make sure you correctly determine your risk tolerance before entering the market.

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