How To Calculate Stop Loss In Crypto Trading
One of the essential skills to master in the fast-paced crypto markets is knowing how to protect your capital aka having a proper risk management strategy. Stop loss is a powerful risk management tool that can safeguard your capital and potentially prevent significant losses.
In this article, we dive into how to calculate stop loss in crypto trading to equip you with the knowledge and strategies to make more informed trading decisions, manage your risks effectively, and navigate the crypto markets with confidence.
How Does Stop Loss In Crypto Work
Stop loss in crypto is a risk management tool that traders use to limit potential losses by automatically selling or closing a position when the market price of a crypto reaches a specified level.
Traders typically set a stop loss order at price levels below their entry price for long positions or above it for short positions. The stop loss order acts as an automated trigger; if the crypto’s price reaches or falls below the stop loss level, the order is activated, and the crypto is sold (long positions) or bought (short positions) at the prevailing market price.
Implementing stop losses is an effective way for traders to manage risk in the crypto markets as it allows them to define their risk before entering a trade.
Where To Set Your Stop Loss For Crypto Trading
There are three main ways that you can use to set your stop losses.
1. Percentage Amount
Setting your stop loss based on a percentage amount allows you to determine a specific percentage decline in the price of the crypto to limit your potential losses. This predetermined percentage is calculated relative to the entry price of the asset.
Say you buy XRP at $0.7061. With a 10% stop loss, you will set your automatic sell order if XRP falls below $0.6351.
2. Dollar Amount
By specifying a predetermined dollar amount as the maximum acceptable loss for a given trade, you can tailor your stop loss to your risk tolerance. This approach ensures that no single trade can disproportionately impact your portfolio which helps to preserve your account and capital over the long term.
3. Price Action
Setting your stop loss based on price action refers to a decision to set stop losses by observing the movement of a crypto price rather than relying solely on fixed percentages or specific numerical values. This approach relies on traders to analyze the price chart and identify key support and resistance levels, moving averages or previous price lows.
Support and Resistance Levels: Support levels are price points at which an asset historically tends to find buying demand and prices bounce back up, while resistance levels are levels at which selling pressure tends to increase and prices fall back down.
Placing a stop loss just below a support level (for long positions) or just above a resistance level (for short positions) is a way to protect against potential breakdowns or breakouts that could result in larger losses.
Moving Averages: Moving averages are trend-following indicators that smooth out price data over a specific time period. Traders often use moving averages as dynamic support or resistance levels.
Placing a stop loss just below a moving average (for long positions) or just above it (for short positions) can help traders exit a trade if the price breaks through the moving average, signalling a potential trend reversal.
Previous Price Lows: Placing stop losses below previous price lows (for long positions) or above previous price highs (for short positions) is a stop loss method that takes historical price action into account. If prices return to these levels, it might suggest a change in the trend or momentum.
The primary advantage of setting stop losses in these strategic locations is that it provides a clear exit plan based on technical analysis.
Say you buy XRP at $0.7066. Based on the recent price action, you can set a stop loss below the recent price lows at $0.6659.
The effective implementation of stop losses in your trading strategy can help you navigate the crypto markets with confidence, allowing you to seize opportunities while minimizing risk. But it is important to remember that no strategy is foolproof, and there is always a risk of price fluctuations and market volatility. Traders should adjust their stop loss levels based on their risk tolerance and market conditions.
How To Calculate Stop Loss In Crypto
Calculating your stop loss requires the following :
1) Entry price
Price at which you enter your position.
2) Percentage/dollar amount of risk
The percentage or dollar amount that you stand to lose if prices go against your trade position.
These are the formulas on how to calculate your stop loss:
Long position: Entry price - (percentage/dollar amount of risk)
If you entered a long position in Bitcoin (BTC) at $40,000 and are only willing to risk 7% on that position, your stop loss will be set at the $37,200 ($40,000 - (7% x $40,000) price level. If BTC prices fall, the maximum amount you would lose is 7% of your initial position.
If you decide to risk a dollar amount instead, say $1,000, you would set your stop loss at $39,000 ($40,000 - $1,000).
Short position: Entry price + (percentage/dollar amount of risk)
On the other hand, if you decide to take a short position in BTC, with the same $40,000 entry price and 7% risk level, your stop loss will be set at the $42,800 ($40,000 + 7% x $40,000) price level. If BTC prices rise, the maximum amount you would lose will be 7% of your initial position.
If you decide to risk a dollar amount of $1,000, you would set your stop loss at $41,000 ($40,000 + $1,000).
Stop Loss Calculator Crypto
For Excel and Google sheet lovers, here are the formulas that you can use to calculate your stop loss (based on the 7% stop loss amount in the example above).
X = Entry price
For long positions,
=X-(X*0.07)
For short positions,
=X+(X*0.07)
Disclaimer: This material is for information purposes only and does not constitute financial advice. Flipster makes no recommendations or guarantees in respect of any digital asset, product, or service. Trading digital assets and digital asset derivatives comes with significant risk of loss due to its high price volatility, and is not suitable for all investors.