Stop loss (SL) is a method of capital protection and investment risk management. Capital management is one of the most important skillsthat an investor must have. Apparently it is much harder to maintain capital than to earn it. In this article, we show how to independently assess the risk of investing in bitcoins, cryptocurrencies and other assets, as well as how to use the stop loss on the cryptocurrency market.
The article is part of free training Cryptocurrencies - how to start and survive? A course for everyone!
You do not invest? You lose capital!
Investing always comes with risk. However, it is impossible not to invest. As experienced economists and stock market players say - lack of position is also a position. Keeping your savings in dollars or Polish zloty, you have long position on this currency, that is, you are playing to increase or maintain its value in relation to products and services. Unfortunately, inflation means that fiat money regularly loses value. Therefore, keeping savings in zlotys, according to the NBP and GUS data, you lose a few percent a year. With the fact that these are data on inflation tested by the basket method prepared by the Central Statistical Office. They do not take into account the huge printing of unprinted money. They also do not take into account that the purchase of a house or flat is a major part of the family's total expenses in its entire life, and housing is up by almost ten percent year-on-year. An increase in the price of parsley by as much as 100% will not affect the average Kowalski, just like the increase in the apartment price by one hundred thousand zlotys, for which he has been collecting for many years.
Bank deposits are very safe, but their interest rate is low enough that it does not compensate for inflation, so we are still losing. In addition, in difficult times banks may fail, and the guarantee fund to insure our funds is not without bottom (especially after the SKOK crisis).
Treasury bonds also have low interest rates. They are supposed to be safe, but how many countries have already gone bankrupt? Even old Polish treasury bonds were not realized - the state cheated, people lost their savings.
If we do not want to give up inflation, we should invest.
Stop loss - what is it?
By investing capital, we decide on the risk of losing all or part of it. The most important is to be able to determine the loss of how much of the capital we are able to afford. When buying an asset, you should not only dream about super profit. It should also be compared to a possible loss if the course goes not in the direction in which we would like to.
We buy bitcoin for $ 10000. What are our assumptions? Do we want to keep it for another year, two, five or up to some price level - $ 20000, $ 100000? We assume we'll keep up to three years and sell for $ 50000. However, what will we do if the price drops to $ 9500 or $ 8000 after our purchase? Will we keep it? What if it keeps falling? Do we have any stop loss, or strategy, what to do when things go wrong. How much are we willing to lose? Did we ask this question before we bought this bitcoin?
Some investors would say that you need to hold the asset for so long until it comes out again, because it does not sell at a loss, and until it sells, there is no loss.
I do not agree with such a statement. The loss is at the time of purchase. We had dollars or zlotys, and now we do not have them, we lost them because we can not buy basic products for them. What if the price never returns to the one we bought? We will wait a year, two, five, ten freezing capital, which could earn for us in a different investment. What if the price never reaches this value? We will never sell and we will argue that there is no loss? What if we get sick and need these funds for treatment, and they will be in a lossy investment, at any given time - 80%? And what if the price drops to zero? We do not have a stop loss, we accept a loss of 100% of invested capital.
Types of stop loss
Diversification assumes the breakdown of all accumulated capital into many different investments, each of which involves a certain risk. Before investing, we need to assess how much we can gain and how much we can lose. Is the ratio of possible profit to loss high enough, is this investment worthwhile? If we decide on it, what stop loss mechanism will we use to not lose more than we agree. Will we sell at a loss at a predetermined price?
Stop loss on capital
If we are dealing with a very risky investment, and long-term investment in such should be one Bitcoin or even short-term w altcoiny, you should consider the use of stop loss on capital. What does it mean?
We invest in only a part of our savings (eg 2% of capital) and accept the loss of everything we have invested. We will not sell at a loss. We will keep it until we have a satisfactory salary. If the price of a given cryptocurrency drops to zero, it is difficult. The risk was included in the investment. It does not mean that we will lose all savings, because the funds invested were only a percentage of what we have.
Stop loss on capital is a good way to invest in less known altcoins, because the risk of falling such a project is very high, and the liquidity of the stock market is usually very weak, so we are not able to buy / sell more tokens without significant price change. On the other hand, it is possible to increase the price of altcoin by several thousand percent, so investing even small capital you can count on a lot of profits.
Stop loss on price
If the price of a given cryptocurrency drops to the level specified by us, we will sell it at a loss.
Using the knowledge of the technical analysis of charts, we look for the right moment to buy. We calculate that it is possible to increase the price by a certain percentage and we set our "take profit", i.e. the assumed moment of profit taking. At the same time, we evaluate when to sell at a loss if the price does not go as we want. We calculate the ratio of possible loss to profit (risk / reward).
The tool "go long" on is helpful in this tradingview (as in the example above). We are developing the simulation of our investment. We measure how much we can gain (79% on an example) and how much to lose (6%) if we set a stop loss at a given level.
There is no reason to be deceived that we will be error-free every time and we will always earn. Stop loss is as real as a profit, so you should not be excited about losses and dream of profit. It is necessary to calculate everything carefully, without emotion managing our capital. The stock market is losing everyone, and the trick is that in the long run the capital lost in the stop loss would be less than that earned in successful investments.
Due to the high price volatility of cryptocurrencies, the stop loss on the price of bitcoin can amount to several percent, and on the price of altcoins even several dozen percent. Investing in altcoins does not facilitate their valuation in Satoshiand not in dollars. For this reason, before investing in a given cryptocurrency, it is worth assessing the loss of the amount of funds we accept. Then, let's use a stop loss both on the capital and on the price, so that in the end the possible loss is not higher than the rate we are willing to pay for the test of earning on the stock market.
Top Cryptocurrency exchanges they offer automatic stop loss orders. After buying a given cryptocurrency, if you do not intend to keep it for a long time and do not pay for your own secure wallet, we can set the stop loss order immediately. We can choose from two options, limit and market.
Stop loss limit
If the price falls to the value we set, our offer to sell the given cryptocurrency at the price we set will appear on the stock exchange and will be waiting for the buyer who will use it. If the price will fall very rapidly, our offer may not be realized and the price will go down.
Stop loss market
If the price falls to the value specified by us, our cryptocurrency will be immediately sold using the purchase offers available at the moment. If there is a sharp drop in prices, running at one time can be a lot of stop loss market and, as a result, we will sell our cryptocurrency at a heavily discounted price.
Stop loss - advantages and disadvantages
Stop loss on capital is an excellent method of its protection. We know exactly how much we risk, how much we can lose. Its disadvantage is the smaller possible profit than if we invested all capital. The opposite of stop loss on capital is leverage. It allows you to play with more capital than you have. This option is available on the stock exchange Bitmexon which you can easily reset your account, but you can also earn large profits faster.
Stop loss on the price is very difficult to set in the right place. It often happens that the price will come to our stop loss, run it, sell it at a loss, and the price of a given cryptocurrency return to a higher level. As a result, the stop loss will make us sell in the local hole. You also have to be reckoned with this. In addition, most people, using technical analysis of charts, set a stop loss in similar places. Sometimes they use it whales they play stop-loss to buy cheaper for themselves, thus throwing out other investors from the market.
An automatic stop loss, set as a limit or market order, has the advantage that the decision based on it was based on cool calculations. In contrast, manual sales, in the case of price drops, can be done in emotions, not always in line with our original intention.
As you can see, each option has advantages and disadvantages, and the combination of various management and capital protection techniques should be your own investment strategy.