When we are dealing with such an unstable market as the cryptocurrency market, the most difficult task is to limit losses. Many investors, unfortunately, learned about it from their own experience during the recent fall of bitcoin. And the rollback does not happen: the crypto currency is continually trying to rise to at least $ 12,000 and repeatedly falls back below $ 10,000.
Fortunately, for this case there is a solution – automatic sale when falling to a certain price (the function is available, for example, on stock exchanges GDAX, Bittrex or Binance). Traders call this tool a stop-loss.
Stop-loss is an order for a broker to sell a crypto currency when a certain price is reached. It is designed to limit the losses of the investor. Although most investors, speaking of stop loss, have in mind a long position, it can also protect a short position – in this case, a crypto coin, on the contrary, is acquired when its value rises to a certain level.
Stop-loss is very important. Let’s look at several options for using them.
1. Save your money. In this case, we prevent the loss of initial investment by automatically closing the position (going into cash) as soon as the value is lowered to the purchase price (or slightly higher, given commissions).
2. Do not get out of a bad situation into a worse one. Here we are limiting losses – you choose a level that is comfortable for you, and thus you get some space for manoeuvre in anticipation that the asset price will grow again.
3. Get at least some profit. You expect the price to be even higher, but want to guarantee a profit.
A novice trader simply buys a crypto coin and hopes that tomorrow its price will be higher, but we proceed from the fact that you are already ready to learn something. If so, let’s discuss several methods for using stop-loss.
Full Stop Loss
This is the simplest type of stop-loss. Black and white strategy: you wake up in the morning, and you either have bitcoins (or another crypto currency) or not.
For example, Bob has 1 BTC, and he worries that during the night the price of bitcoin will fall below $ 9,000. He places a stop-loss, informing the exchange/broker that if the price falls below $ 9000,his/her 1 BTC must be sold. The advantage of this kind of stop-loss: if the price really falls below $ 9000 and remains low, Bob will be protected from losses and he can buy his bitcoin back at lower price.
Disadvantage: during the night, bitcoin may fall below $ 9000, but then climb back and even exceed this price level. In this case, it turns out that Bob will losse (if he wants to still keep bitcoin in his portfolio).
How can Bob act in this situation? Unfortunately, there is no perfect solution, but there is a compromise – a partial stop-loss. That is, when the price falls below $ 9000, 50% of Bob’s asset will be sold.
If after the fall the price rises, for example, to $ 10,000, then Bob will still have half of his bitcoin, and some flexibility in further action. For example, he can immediately buy the sold back, and the loss will be less than with a full stop loss.
If Bob believes that the price will fall further, he can sell the remaining half of the bitcoin, and then buy again – but at a lower price. In any case, if you use a partial stop-loss, if the price moves back, it will be in a better situation than the full stop-loss.
The problem is that if bitcoin falls below $ 9000 and remains there, it turns out that Bob got rid of only half of his asset, and now he will have to suffer additional losses, selling what he has at a lower price.
Trailing Stop Loss
Bob begins to think further – after all, bitcoin can soon collapse again, and you need to be ready for this.
One of the problems of the partial stop-loss (and the complete stop-loss) is how to find out at what level it should be applied? Suppose that the current price of bitcoin is $ 10,000. Bob believes that it will drop to $ 8,500, and decides to set a stop-loss at $ 9200. So if the price is $ 8500 in the morning, he will be able to buy back 1 BTC for $ 8500 and put another $ 700 in his pocket (or buy another bitcoin, which is much more likely in the case of Bob).
But what if the price drops only to $ 9000? This will mean that the stop loss at $ 9200 was low because the spread on which Bob planned to earn was less than it could be (in this case the spread is defined as the difference between the price at which you sold and the current price).
Therefore, our Bob decides to use a partial stop-loss and distribute it on the range between the current price and the lowest threshold of the stop-loss at which he is going to exit the position.
So the sequential passage of stop-loss will allow to realize the so-called dollar-cost averaging strategy – in this case you gradually exit the position while the price moves from the current to the set exit price in order to increase the average exit price.
Consider again the previous scenario: suppose bitcoin costs $ 10,000, and Bob thinks he’ll fall to $8,500. However, he is not totally sure of his forecast, then he would prefer a more conservative strategy – in case the price jumps up or does not reach this price. In this very simple case, instead of setting a full stop-loss at $ 9,000, he can ask to sell 0.2 BTC at $ 9800, another 0.2 at $ 9600 – and so on to $ 9000, hence the average exit (closing) price will be $ 9,400 rather than $ 9,000. If the price stops at $ 9000, it will still work on the $ 400 spreader, not $ 200, as in the previous example with one stop-loss.
Which option to use
Unfortunately, there is no right answer – it depends on many factors.
Note that the strengths and weaknesses of all three strategies have been described only in relation to the given scenario, and we have not touched on a lot of arguments for and against.
If you are trying to trade on fluctuations or short in a bear market (both are extremely risky), your actions will in any case depend on what bitcoin prices you are expecting in the near future, and how confident you are in your forecast.