Cryptocurrencies and stocks are rapidly becoming popular investment options, especially among younger generations. This is likely due to the convenience of trading digital assets and the decentralized nature of the market.
However, despite the convenience and high-profit potential, it’s also very important to note that the cryptocurrency market is distinctly volatile. So, investors are advised to be cautious.
Actually, there is a variety of tools to mitigate losses in their investments. One of these tactics is stop-loss.
Learn more about stop-losses, their utilities, types, when to use them, and why it’s important for crypto investors in this article.
What is Stop-Loss?
Short answer: Automatic liquidation of assets when its market price reaches a certain level.
A stop-loss or stop-loss order is the automatic liquidation of assets when the market price reaches a certain level. Users stipulate the price at which a stop-loss occurs.
Stop-losses were created to diminish losses if an asset price does not rise as expected, or more importantly, rapidly falls.
Multiple cryptocurrency exchanges offer this feature. In fact, experienced traders or investors typically put in a stop-loss order whenever they purchase an asset.
Stop-loss example:
Rosie paid US$41,000 for 1 Bitcoin (BTC).
Rosie then puts a stop-loss order for 10% (US$4,100) below the purchased price. So, any time her Bitcoin is worth US$36,900, the system will immediately liquidate her assets.
As a result, even if the price of Bitcoin falls by over 20%, Rosie will only lose 10% of her investment.
The functions of stop-losses
As we can see from Rosie’s situation, stop-losses can provide benefits to traders. So, now that we know why they’re helpful, here are the top 3 functions that stop-losses can provide.
Gaining profits
While waiting for the red candlestick to turn into a green one, an investor or trader could profit from this strategy.
However, the profits generated will be relatively small.
See more: What are candlesticks in cryptocurrency charts and what do they mean?
Maintaining investments
This technique allows investors or traders to maintain their investments’ monetary value by liquidating them when the market price falls below the purchase price.
Avoiding massive losses
An investor or trader can use this strategy to avoid losing massive amounts of money when an asset’s value plummets.
When to use stop-losses
While limit orders are used to maximize profit from current trends, stop-losses are employed by traders to minimize losses.
Stop-loss orders are used to increase investors’ control over trading risk factors that will occur in the future. Thus, the best time to use it would be in the present i.e. whenever you purchase a volatile asset.
See more: What you should do in a volatile market
Types of stop-loss orders
There are three types of stop-loss orders to keep in mind. Read on to find out what they are, how they work and when to use them.
Full stop-loss
In a full stop-loss order, the exchange will liquidate all units of the asset when it reaches a certain price.
Traders or investors typically use this strategy in a stable market with high price volatility, as predicted price drops are relatively modest.
Partial stop-loss
Partial stop-loss orders tell exchanges to only liquidate a portion of a trader’s or investor’s assets when its value hits a certain point.
This strategy is generally used on volatile investment instruments, such as cryptocurrencies, to ensure that the investor retains some of the assets in case the price rebounds and skyrockets again.
However, there is no guarantee that the asset’s price will return to normal or if it’ll drop even further. As a result, the trader may still endure a loss.
Therefore, traders who intend to use it must understand that this type of stop-loss carries a high risk.
Trailing stop-loss
In the first two types, traders stipulate the exact point at which an exchange should liquidate the asset.
Trailing stop-losses, however, do not just have one set price point for liquidation. In fact, the point rises – but doesn’t fall – along with an asset’s price.
When an asset’s price increases, the stop-loss order will trail behind it. This strategy requires users to determine the trailing distance, which is the difference between the current asset price and the value of the stop-loss.
Example:
Sally buys NEAR Protocol (NEAR) at US$30 and stipulates her trailing distance at US$0.10. Thus, her stop-loss order is set for US$29.90.
If the NEAR price rises to US$35, Sally’s stop-loss order will automatically change to US$34.90. However, when it falls to US$30, her order remains at $US34.90.
The dynamic adjustment of the stop-loss order allows investors to maintain the upside of trades while also mitigating their losses. As a result, it’s also called a “protect stop.”
Why is stop-loss order important?
Stop-loss orders are intended to reduce losses incurred by market fluctuations. As you may know, market trend fluctuations can cause you to lose some assets, or even a large sum of money.
When a trader or investor employs a stop-loss order, regardless of the type, they must consider the risk and potential profit.
Finally, stop-loss orders are just a tool. The effectiveness of an order is determined by how well a trader performs their market analysis.
Get a feel for the market with Zipmex
The best way to mitigate yourself and your assets would be to do thorough research. One way to do that is to read through our guides on different investment strategies, markets, and coins on Zipmex Blog.
However, if you learn better by doing, then sign up for a Trade Wallet. Zipmex has a multitude of different coins including Bitcoin (BTC), Ethereum (ETH), NEAR Protocol (NEAR) and Litecoin (LTC) offered at the best prices and lowest spread.
