Essential Stop Loss Features for Cryptocurrency Trading

Trading in the high-risk arena of cryptocurrencies comes with risk. Although there can be huge profits to be earned trading volatility, traders can just as quickly lose huge amounts of money. Most professional traders demonstrate their professionalism not because of how much they can earn but how well they manage their risk to achieve long-term success in the digital asset market. The best way to protect your capital and ensure long-term survival is through the use of advanced stop loss features.

The Importance of Trailing Stop-Loss Features

Standard stop loss orders (also referred to as static or fixed stop-loss orders) are set at a particular price. The cryptocurrency markets, however, tend to be persistent, meaning that they can exhibit a trend for extended periods of time. This is how using trailing stop-loss features becomes effective and beneficial for traders. Trailing stop-loss features operate automatically versus manually and can help secure profits as a trader's position in either Bitcoin or Ethereum appreciates.

How Trailing Stop-Loss Works

When a trader sets up a trailing stop, the trader selects a trailing amount (percentage amount or dollar amount) from the current price of the asset. The price of the trailing stop increases at the same time that the BTC and ETH prices are increasing. When the prices stop rising and start to decline, the price of the trailing stop will remain at the last highest price achieved. The order will execute once the price declines below the trader's designated trailing percentage.

Selecting a Good Trailing Percentage

Finding the best trailing percentage for your trading is important. If you set your trailing percentage too tight (1% for example), your sell orders will be triggered by small price fluctuations. On the other hand, if a trader sets the trailing percentage level too wide (e.g., 15%), the trader may give back a lot of the profit they initially made. Traders in the cryptocurrency market often rely on the Average True Range (ATR) as a measurement for determining a certain percentage based on natural fluctuations/volatility for that asset.

When markets are bullish and prices move up rapidly, such as during a 50% increase or more over an extended period of time without any meaningful pullbacks, trailing stop losses can provide you with the ability to ride this trend to its peak. Rather than having to make an emotional decision regarding where the top will occur, a trailing stop loss allows your position to automatically exit through a sell order as soon as an opposing trend emerges.

For traders who take short positions, the market has a tendency to put them at risk of "short squeezes." A trailing stop-short functions identically to a trailing stop loss, providing capital protection while the market is bearish in nature.

When you take a short position you want your short price movement to be down. The trailing stop-short follows this short term downward price movement. If, at some point, that asset starts to recover in price from its low and hits your trailing stop-short threshold, it will be sold to close out your short position. This means that you will not turn an eventual winning trade into a losing trade through a sudden price movement.

In most volatile corrections in the crypto marketplace, there are often several small relief rallies followed by a definitive bottom, and the market begins to move back up. A trailing stop-short will provide you with the tools necessary to remain in a trade through small relief rallies while giving you the confidence to exit once the market has reached its bottom and is in an upward trend. 

The Use of Trailing Stop Buy Features

Most traders focus on selling, but trailing stop buy features can also be effective in precisely refining an entry point. Trailing stop buy orders can be effective for both entering at the bottom of a market as well as entering a position after a breakout has occurred.

Trailing Down to the Bottom

Instead of trying to catch a "falling knife" (by utilizing a fixed limit and market order to get in at the bottom), a trader can utilize a trailing stop buy order which will follow the asset down. The trailing stop buy order will only trigger an actual buy order after the asset (or price) has retraced a certain percentage from its low.

Automated Tools To Time Your Entry

Automated crypto-trading bots and many of the advanced cryptocurrency exchanges such as Coinbase or Binance allow traders to easily use these types of orders combined with technical indicators to time a market entry. As an example, you could set your trailing stop buy to only trigger when the RSI indicates that it is at an oversold level. This will help to improve the chances of successfully entering the market.

Learning the Basics of Stop Loss Orders

Although trailing stop buy features can offer many options, every trader should first learn how to use stop loss orders in order to keep their profits and limit their maximum loss.

Fixed Price Stop Loss Orders

To sell an asset when it reaches a pre-determined price, a trader may use either a stop-market order or a stop-limit order as their fixed price stop loss orders.

• Stop-Market Order: Guarantees that a market order will be executed when the stop price has been reached, although there is no guarantee that the order will be executed at the expected price (slippage).
• Stop-Limit Order: Becomes a limit order when it is executed at the stop.

The stop-loss order allows a trader to decide how much they will lose if their order gets filled. The limit price is also determined by the trader. A trader only gets filled at their limit price if it is within the price range set by them (e.g., if the trader set their limit price at $30,000, then they will only get filled at $30,000 if, in the market, there are two buyers willing to buy at $30,000 and one seller).

Calculating Your Optimal Stop-Loss Level

The best way to calculate your optimal stop-loss level is using support and resistance levels (determined by how much a security has dropped in price). For example, if the price of Bitcoin has strong support at the $60,000 level, place your stop loss just below this level (e.g., at $59,400); this will keep you from being "wicked out" (filled on a stop-loss) due to minor fluctuations before the price continues to rise.

Sell with Profit Strategy

This is an advanced trading strategy used primarily in the "cryptocurrency" markets, where the trader will typically never exit a position unless it results in them making a profit. While this strategy is psychologically beneficial for traders, it takes a lot of discipline to implement properly.

When to Use a Take-Profit Only rule

When using a "Profit-Only" trading rule to trade long-term positions in high-conviction assets such as BTC or ETH, a trader is ensuring that they are only going to trigger a sell order at a price greater than their initial entry price. This means that, in the event of a price "wicking," there is no way for the trader to lose money on the trade.

Advanced Stop-Loss Strategies for Inexperienced Traders

As a professional trader, managing risk is generally accomplished through multi-tiered systems for trade exits. Instead of closing a position entirely, professional traders set multiple stop-loss orders on the same trade at various price levels (this is referred to as "laddering" the stop-loss); this allows for partial profits while maintaining some exposure if the market experiences extreme volatility.

Testing Your Stop-Loss Strategy

No stop-loss strategy is perfect from the start. In order to find out how effective your different parameters are you have to take a close look at your traffic and trade data.

• Backtesting: To see how your trailing percentage would have fared in prior market conditions, you can look back through historical data.
• Fine-tuning: Generally, coins that are less volatile (such as Bitcoin) will typically require tighter stops than very volatile coins (such as altcoins).
• Reviewing: Traders' stop-loss settings should be reviewed weekly to make sure they are still effective since the market changes frequently and profit protection is the primary goal.

Conclusion

Utilizing effective stop loss features is primarily about creating a framework for success. By utilizing tiered exit strategies, stop buys, and trailing stops, you can reduce risk and gain confidence while trading in the highly volatile crypto market. The ultimate goal of using a stop loss is to remain in the game long enough to find winning trades.

FAQs

How do stop loss percentages differ for Bitcoin and Altcoins?
Bitcoin is generally much less volatile, so a stop of 3-5% may be sufficient for Bitcoin. An altcoin generally requires a stop of 10-15% due to daily price fluctuations.

What are the drawbacks and risks of using trailing stops in a highly volatile market?
In the event of a "flash crash," the best price available may be much lower than the price associated with your stop loss, and as a result, you will be stuck with slippage (the difference between the stop price and the execution price). Additionally, as a result of whipsaw price action, your stop loss may be printed as the price is going back in the direction that you wanted.

When using DCA, can you also use a stop loss?
Yes, DCA is a method for accumulating, so if you would like to protect your investment from a complete trend reversal, you can combine DCA with a stop loss on the complete amount of accumulated positions.

How often should I adjust my stop loss parameters?
Review your stop loss parameters whenever a market cycle changes (e.g., trending to sideways) or after major news stories that would create a higher level of volatility in the market.

What is the difference between an exchange-based stop and a bot-based stop?
Exchange-based stop order is placed on the book of orders, whether they are visible or not, which provides for quicker execution. Conditional orders placed by a bot are off-exchange until triggered, which helps to mitigate the impact of "stop hunting" but adds risk due to technical and operational issues should the bot's API fail.