Stop-loss limits are an essential risk management tool for crypto traders looking to limit their downside risk.
Read on to learn what stop-loss orders in crypto trading are, how they work, and how you can use them to manage your risk.
What Is Stop-Loss in Crypto?
A stop-loss is a conditional trade order traders use to enter or exit a position to limit their downside. The condition is the crypto asset’s price movement reaching a predetermined level.
With a stop-loss limit, you can specify the lowest price point at which the exchange will activate your buy or sell order.
Given the cryptocurrency market’s volatility, stop-loss limits are crucial in risk mitigation. Price movements can be sharp, making it challenging to place manual buy and sell orders at the right time.
Stop-loss limits can improve traders’ risk management measures by taking emotions, such as fear and greed, out of the equation when making trading decisions. Traders often get carried away and might be drawn to trading decisions without a sound basis. Automation tools such as stop-loss limits address this, with traders selecting price limits based on their analysis and risk profile.
Types of Stop-Loss Orders in Crypto
There are various stop-loss orders you can use in your crypto trading.
A trailing stop-loss order lets you set a trailing distance, which is the difference between the crypto asset’s price and the stop-loss amount. A rise in the market price leads to an equivalent rise in the stop-loss amount. A negative price movement sees the stop-loss limit remain the same, and the order activates if the market price reaches the limit.
A trailing stop-loss order helps you avoid having to change the stop-loss due to changes in the market.
A full stop-loss order activates a sale or buy order when used. If the price moves against you, you will fully exit your position. Should the price move in your favor, your downside will remain limited to where you originally placed the stop-loss.
A partial stop-loss order allows you to partially exit your position once the price declines to the target level. Your portfolio remains with a portion of the asset, and in case a price surge follows the drop, you will still have skin in the game. However, if the price declines further, you will be stuck with a part of your position in the red.
Benefits and Limitations of Using Stop-Loss in Crypto Trading
Stop-loss orders offer significant benefits but have some limitations as well.
- Minimizes the influence of emotions: Stop-loss limits allow traders to focus on the market conditions and their risk tolerance rather than succumb to the pressures of their emotions.
- Risk mitigation: Since risk tolerance is one factor that influences the set stop-loss limit, a trader will make trading decisions based on the level of risk they can handle.
- Market order differences: The volatile nature of the cryptocurrency industry means that some orders may not be filled because the price would have fallen further in the time it takes for the market order to be active.
- Short-term fluctuation: A stop-loss limit may lead to a trader exiting a position after a brief negative price movement. The trader will lose out on the potential profit if the market rallies and the price rises beyond previous levels.
Should You Use Stop-Loss Orders in Crypto Trading?
Stop-loss orders are helpful in crypto trading, given their benefits in risk mitigation and minimizing the role of emotions in trading. However, they don’t guarantee success, so you must use them alongside other trading strategies.
Remember that crypto assets are highly volatile, and you can still make losses while using such tools, especially if you aren’t experienced in using them.