7 Best Stop Loss Strategies For Crypto

Effective risk management is an essential aspect of successful cryptocurrency trading. As the crypto market is notorious for its volatility, traders must implement proper risk management to mitigate potential losses and protect their investments. Among these risk management strategies, stop-loss orders have emerged as a popular tool for minimizing downside risks.

A stop-loss order allows traders to automatically sell a cryptocurrency when it reaches a predetermined price, helping to limit losses and preserve capital. In this article, we explore 7 of the best stop-loss strategies for crypto trading, providing insights into their implementation, advantages, and considerations. Whether you're a seasoned trader or just starting your crypto journey, understanding and utilizing these stop-loss strategies can be a game-changer in navigating the turbulent waters of the crypto markets.

What Is A Stop Loss In Crypto Trading

Stop loss orders in crypto are advanced orders placed with a broker to buy or sell a specific crypto once the crypto reaches a particular price point. Once the price of the crypto reaches that predetermined price point, the stop loss order becomes a market order that is executed automatically.

Suppose you bought Bitcoin (BTC) at $30,000 and before buying the crypto, you placed a stop-loss order at $27,000. If BTC falls below $27,000, you will be liquidated out of your position in BTC at the prevailing market price. So for example, if BTC falls to $27,000 and your stop loss order is filled, the loss that you will suffer is limited to 10% (($30,000 - $27,000)/$30,000).

Stop-loss orders are designed to allow crypto traders to manage their risk and limit their potential losses on any given trade. In addition, with stop losses, crypto traders can plan their exit points and the risks that they are willing to take on before they even put on their positions. These give crypto traders a huge advantage in the crypto markets.

The Importance Of Setting A Stop Loss In Crypto Trading

While we have touched on some of the benefits of setting stop losses when trading crypto above, the benefits do not stop there. These are some of the other benefits of setting stop losses.

Protect Profits

Many traders tend to view stop losses as tools to help them limit their losses. That is certainly one of the most useful ways that traders can utilize stop losses. However, the usefulness of stop losses goes beyond just helping traders limit their potential downsides. Stop losses can also help traders protect their profits in the crypto markets.

After the prices of the crypto that a trader buys have risen, he or she can set a stop loss to ensure that they lock in a certain amount of profits. For example, if the price of Ethereum rises to $10,000 after the trader bought it at $5000, the trader can set a stop loss order at $7500. Setting a stop loss at that price level ensures that the trader can lock in a gain of at least 50% assuming that prices do not gap down.

Remove emotions from the selling process

By setting stop losses, crypto traders’ open positions are automatically closed once prices hit the predetermined level. This helps remove emotions from the selling process. Selling out your position can be one of the most difficult things when trading as it usually means that you are wrong. Many traders would rather take a loss than admit that they are wrong because of ego.

However, this delay may only lead to greater losses. There is a well-known saying, “Your first loss is your best loss.” What this means is that traders are best served to take their first loss, which is usually the smallest loss, before it gets bigger. By making the selling process automatic, stop losses can help traders take their first loss in an emotion-free manner.

Free insurance policy

It costs nothing to set a stop-loss order when trading in crypto. You are only charged a fee when your stop loss order is filled. Using insurance as an analogy, by setting a stop loss, traders essentially get a free insurance policy and they only pay the premium when they need it.

This might seem incredulous as the benefits are overwhelmingly skewed in the favour of traders but this is what happens when you set stop losses when trading in the crypto markets.

Don’t have to sit in front of the screen all day

Stop losses allow traders to set their sell orders in advance thus eliminating the need for traders to sit in front of the screen all day.

7 Best Stop Loss Strategies For Crypto Trading

Dollar Stop Loss

Setting a dollar stop in the crypto markets allows a trader to decide the dollar amount that he or she is willing to lose on that trade. By having that figure in mind, the trader knows beforehand the amount he or she can lose if the trade goes against them.

For example, if you are buying 1 BTC at $30,000 and the maximum amount of risk that you are willing to tolerate is $2000. Based on this amount, you can set a dollar stop at $28,000 which is $2000 away from the entry price.

Percent Retracement Stop Loss

Percent retracement stops are one of the more commonly used stop-loss strategies utilized by traders. This stop-loss strategy allows prices to retrace a certain percentage of the entry price.

For example, if you are buying 1 BTC at $30,000 and the maximum percentage drawdown that you are willing to tolerate is 10%. Based on this percentage amount, you can set a percentage retracement stop at $27,000 which is 10% away from the entry price.

Volatility Stop Loss

Volatility stop losses adapt according to the changing market conditions. During periods of high volatility, stop losses are set wider to account for the greater price fluctuations. Tighter and more conservative stop losses are used when market volatility is lower. One way that traders use to measure volatility in the crypto markets is the average true range (ATR).

For example, if you are buying 1 BTC at $30,000 and the 50-day average true range for BTC is $1000. Based on this average true range, you can set your stop at $28,500 which takes into account ‘normal’ price fluctuations without choking off your trade.

Standard Deviation Stop Loss

According to StockCharts.com, standard deviation is defined as “a statistical term that measures the amount of variability or dispersion around an average.” Standard deviation can be used as a measure of volatility in the crypto markets.

For example, two standard deviations of the price of crypto encompass approximately 95.4% of outcomes in the markets. Using a standard deviation stop loss, you can set your stop loss order two standard deviations away from your entry price which takes into account ‘normal’ price fluctuations without choking off your trade.

Moving Average Stop Loss

Moving averages are calculated to smooth out short-term price fluctuations and help traders identify the trend direction of crypto prices. In addition, many traders also use moving averages as support and resistance levels.

For example, if prices of BTC are above the 200-day moving average when you bought it and after buying, prices fall below the moving average. Using a moving average stop loss, this would be a sell signal.

Time-Based Stop Loss

The idea behind time-based stop loss is that if a position does not go in the favour of a trader within a period, then his or her timing is off which invalidates the trade. A time-based stop loss will get a trader out of his or her position after a fixed period if the trade has not made a certain amount of profit.

For example, if you bought BTC at $30,000 and based on your analysis, you expect prices to move up by more than 5% within the next week. Fast forward two weeks later and prices of BTC are still moving sideways and any move up has been short-lived and not more than 5% from the entry price. Using a time-based stop loss, this would be a signal to get out of your position in BTC.

Fundamental Stop Loss

While fundamental stop losses are geared towards the fundamentals (team, community, whitepaper etc.) rather than the technical and price action of the crypto, these stop losses can be useful for both crypto investors and traders alike.

For example, if you bought ETH because you believed in the Proof of Work consensus mechanism that the Ethereum network uses to verify and secure transactions. But after you bought it, Ethereum transitioned to a Proof of Stake consensus mechanism instead. As the fundamentals of Ethereum have changed, with a fundamental stop loss, this would be a sell signal.

How To Choose Which Type Of Stop Loss To Use

The type of stop loss to use in the crypto markets depends on your trading style.

Shorter-term traders may use a tight stop-loss strategy such as a dollar stop loss coupled with a time-based stop loss, which means that they will set their stop loss closer to their entry price and exit their position quickly if the trade does not go in their direction. Other longer-term traders may use a wider stop-loss strategy like a fundamental stop-loss, allowing prices to fluctuate by a greater extent and only exiting their position if the fundamental reasons change.

A wider stop loss tends to work better for mid-to-long-term traders as the trade has more room to move in your favour before your stop loss is hit. The converse is true for shorter-term and day traders.

Every stop-loss strategy has its pros and cons, there is no one-size-fits-all stop-loss strategy. We have listed down 7 stop loss strategies and you have to determine which one works best for you and your trading style.

Most crypto traders typically focus only on how much returns they can make and place less emphasis on or ignore risk management. However, risk management is an integral part of any trading success and should not be ignored. Stop losses are one way that you can limit risks and losses in the crypto markets and they can play a major role in your trading, risk management, and trading results.

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.