In this article, we will be looking at stop losses. Stop losses are a crucial and widely used aspect of cryptocurrency trading, typically for trade risk / reward management. The stop loss is used in order to prevent a trade from seeing further losses, triggering a sell (or long) order when specified conditions are reached.
When used correctly, stop losses can be highly effective and allow for long term portfolio sustainability. However, like all cryptocurrency tools, indicators, trading bots and metrics they must be used correctly or you run the risk of harming your portfolio.
The two types of stop losses
There are two main types of stop losses which can be used in cryptocurrency trading, trailing stop losses and standard stop losses.
Standard stop losses
The most commonly used stop loss orders are standard stop losses in the cryptocurrency market, mainly due to the high volatility of cryptocurrencies and their simplicity.
Standard stop losses work through setting a position where you want to effectively cut your losses, in order to prevent the trade from going deeper into the red. For example if a BTC long was placed at $20,000 USD, a trader may decide that they will not accept anything beyond a 10% stop loss.
There are many reasons why a trader may wish to do so, here we have listed a few reasons why:
- If a trader becomes easily emotionally attached to trades, ensuring that position is closed as planned
- To prevent the trader getting wrecked in a ‘bank run’ trade
- Risk/reward ratio usage
- To allow for closure of positions if they are busy and unable to trade at that moment in time e.g. the trader is sleeping, driving or having dinner
Standard stop loss example
Continuing with the BTC example, if a trader enters a long at $20,000 USD with $100,000 USD and wants a 10% stop loss, it will be placed at $18,000 USD.
- Long position entry point = $20,000 USD
- Long position entry size = $100,000 USD
- Long position stop loss = $18,000 USD
- Maximum loss on trade = 10% of trade value (in this instance $10,000 USD)
BTC/USD visual example of using a standard stop loss
In this example, we can see that setting a stop loss worked. BTC proceeded to increase in value, soaring to $24,000 USD. When we look deeper into the situation at that time, a stop loss at $18,000 USD made sense. BTC was forming a potential head and shoulders formation, BTC was at ATHs and was at risk of returning to $15,900 USD if the potential head and shoulder formation had its neckline broken.
If $15,900 USD had occurred, not setting a stop loss at $18,000 USD would transform a $10,000 USD loss into around $20,000 USD which would have left the trader likely quite sad…
BTC/USD stop loss example
Although, how did the trader know where to place their stop loss? Why $18,000 not $19,000 or even $19,500 USD? Let’s take a look at how traders decide where to place their stop losses.
Deciding to where to place your stop loss
Deciding on where to place the stop loss is tricky, with the main reason being because of the high volatility of cryptocurrencies. There are many factors which can affect where you decide to place your stop loss, here are a few:
- Location of ascending / descending support
- Key support levels
- RSI value
- Current market sentiment
- Current PnL
- Bitcoin & altcoin volatility
- Timeframe e.g. hourly / daily / weekly
When placing your stop loss you need to find a balance between risking the stop loss being triggered by volatility and limiting your risk.
Cryptocurrency traders have different ways in which they place their stop losses. Some place them just below psychological numbers e.g. $10,000 USD or $50,000 USD. However, placing them just below key support levels is better.
For example, BTC currently has $55,500 USD as a key support level (current price $58,500 USD). BTC could drop to this level, however closure below $55,500 could result in a change in sentiment from bullish to bearish. If BTC fell below $55,500 BTC could see a sell off towards the next key support level at $50,000 USD. Therefore a stop loss at $54,500 USD seems sensible as it would allow for intraday volatility, however if this level occurred, longs would likely be liquidated and it would prevent the position from seeing further red as a drop to $50,000 USD would be likely.
Deciding where to place your SL conclusion
When making the decision there are numerous factors which need to be taken into account. For example with the SL demonstration above the following factors came into play when deciding on the SL position:
- Upwards support would be broken if stop loss was hit, likely seeing further downwards movement
- Current volatility – placing the SL any higher could see the SL hit incorrectly
- If BTC fell below $55,500 USD $51,000 USD would be likely due to current RSI movements
- Lack of previous volume / support / resistance between $55,500 and $50,000 USD
As you can see, there are multiple factors which in this scenario, would affect the placement of the stop loss. Each time you place a stop loss, the scenario will be slightly different so be sure to take everything into account as using a set stop loss procedure likely will not work.