Cryptocurrency Trading Risk Management 101: Psychology’s Important Role When Trading Bitcoin
Back in 2017, Bitcoin (BTC) and other digital assets were reaching all-time highs and levels that nobody was expecting before. Indeed, individuals were selling objects they had or taking credit to purchase digital currencies. Others simply put their life savings into Bitcoin. However, they were not expecting the market to fall as soon as in January 2018.
Investors should know their risk appetite and how trading psychology works before investing in digital assets. This would allow people from all over the world to avoid being rekt.
The market is very volatile and young. This is one of the most important things that an investor should take into account when analyzing an investment in digital assets. This means that the market is prone to irrational exuberance.
Investors should also be ready to diversify their holdings. This is going to be very important for risk management. The best is to have exposure to other assets rather than just virtual currencies. This would allow individuals to mitigate risk. According to Harry Markowitz, a Nobel Prize winner said that diversifying assets allows individuals to minimize risk and get the mean.
“Buy low, sell high” is one of the main advice that investors receive when entering the market. However, is that easy and simple to achieve? Users need to determine when an asset is being traded low and when an asset is being traded high. Clearly, this is something difficult to execute but not impossible.
The market is full of fear of missing out (FOMO) and fear, uncertainty, and doubt (FUD). These two things play also an important role in determining the sentiment that affects the whole market. When Bitcoin was skyrocketing in December 2017, individuals believed that the most popular digital asset was going to reach three digits very soon. Nevertheless, this did not happen. This is a clear example of FOMO, attracting investors even when Bitcoin was close to $20,000 to keep placing funds in the market.
When China banned Initial Coin Offerings (ICOs) and Michael Novogratz mentioned that Bitcoin is a fraud and that governments will crash it, the market dropped. This is an example of FUD. In more mature markets, these things would affect in a much lesser extent specific assets.
There are investors that lost everything in the crypto market. The whole crypto market capitalization dropped around 90% since its all-time high. Bitcoin lost 82% while other assets dropped even further, such as XRP or Ethereum (ETH).
Investing in virtual currencies is very exciting and provides many opportunities for several individuals and investors. However, it is very important to understand which is the attitude towards risk that each individual has and how to be prepared if the market skyrockets or falls.