By Ruud Feltkamp, CEO of crypto trading bot Cryptohopper
Thanks to a viral Super Bowl advert, cryptocurrency trading is now more than ever in the spotlight. The ad saw cryptocurrency exchange Coinbase Global offering $15 in free Bitcoin to new users and the success of that promotion, due to the surge in new customers jumping online to check it out, crashed the company’s app entirely. For anyone interested in investing in cryptocurrencies, there are steps that should be taken before diving in. First, you need to assess your risk appetite and adjoining risk tolerance. Then, you should assess your options to find the right investment assets to trade in but, perhaps most importantly, you really need to consider exactly what type of trader you are.
Table of contents
As a potential investor in cryptocurrencies, you have access to a massive selection and variety of digital coins to choose from. Not only are you picking what type of cryptocurrency you want to trade in – DeFi, NFT, utility tokens, store of value tokens or yield farming tokens – but you also have the choice of which of the many different digital coins there are, which are available to trade in: Bitcoin (BTC), Ethereum (LTH), Polkadot (DOT), Dogecoin (DOGE), Stellar (XLM), Binance Coin (BNB), Cardano (ADA) and Litecoin (LTC) are just the tip of the iceberg when it comes to options.
But, not all of those digital coin options are equal or even similar in all aspects. As with any other types of investment, cryptocurrencies come with their own individual risk and return profiles. So, before you choose which option to invest your money in, ideally you should make it your first priority to ensure that you are in a position to pick and choose the one that suits your trading needs, budget and requirements best. This can be done quite easily, by analysing and understanding your risk appetite, to help you identify which trader type you are – conservative, moderate or aggressive.
Understanding risk appetite
Risk appetite is simply the maximum amount of risk that you, as a trader, are ready and willing to take – e.g. how much risk can you stomach? Each and every trader has their own unique risk appetite. Based on your own individual ability to psychologically and financially handle the possibility of a negative outcome and how in need you are of the outcome to be positive and not negative.
These answers are not the same for every would-be trader. But, you can easily calculate yours by looking at how likely you are to trade in something that is more likely to be riskier than beneficial, but at the same time brings with it a far higher return on your investment. To achieve your financial return objectives, are you willing to trade in a digital coin that has more risks outweighing its potential benefits, or not?
A high risk appetite trader would be someone who tends towards chasing high financial returns but, due to that, is happy to also do so despite a high level of risk involved with that option, such as losing a major part of their investment capital in the process. For example, picking an investment option that offers a return of 30% per annum, but could mean losing up to 55% of capital investment is a high risk option.
A low risk appetite is someone who prefers to preserve their capital investment and decides against chasing high returns because of the higher amount of capital risk involved in that. So, for example, they choose to invest in an option that has a more modest 6% return per annum but which also has a lower risk of capital investment sitting at 8 – 10%.
Understanding risk tolerance
There is also an element to consider when determining risk appetite in how much money you can reasonably afford to lose and the amount of time that you have to ride out the investment. For large-scale companies and traders that are happy to invest in crypto, and can handle price swings in a rational manner, their risk appetite would be high. For an older couple that may be investing their savings for retirement and would likely panic at any small change or decrease, or just reconsider their options at each step, their risk appetite is low.
Recent dip in appetite
Cryptocurrency, and in particular Bitcoin, has seen a significant jump over the past two years, from just shy of $7,000 at the beginning of 2020 to almost $70,000 in November 2021. However, past performance is not an indicator of future growth and there was a dip over the festive period straight after November 2021, before Bitcoin swung back above $40,000 in February 2022 as risk appetite returned.
Investing in a range of assets diversifies your trading so, based on your risk appetite and risk tolerance, which classification of trader type are you?
1. Conservative: A conservative trader is someone who prefers to take a cautious approach. Conservative crypto traders usually go for the top 20 or 50 coins that have proven themselves already. Even for conservative investors, these coins will still offer great returns when the market is bullish and usually won’t lose more than 30% in a couple of days. Trading decisions are usually based on longer period and use candle sizes of a week or a day.
2. Moderate: A moderate trader is a person who tends to take a slightly more calculated risk in search of moderate to high returns. The moderate crypto trader also trades coins that aren’t in the top 50 or 100 and are willing to put a percentage of their funds in these coins. Exposing themselves to these coins can result in higher profits but also increase the risks due to more extreme volatility. Usually, the holding time is also shorter compared to conservative investors. The candle sizes this type of traders look at are usually the four hour and 1 day candles.
3. Aggressive: An aggressive trader is a person who loves to take risks and adopts a markedly optimistic approach towards investments. The aggressive trader trades the cryptocurrencies with low volume and a low market cap. Aggressive crypto traders usually look at lower smaller candle sizes, such as 1, 5, 15, 30 min and hourly candles. These traders are also willing to invest large amounts in lower market cap currencies.
Investing can be risky. As is true in all investments, striking the right balance between the financial and emotional sides of crypto trading is key to success. You need to be able to cope with and afford any drops, but you should also consider the purpose of the investment – is it to increase savings for a long-term future purchase like a house, or is it just an experiment, where you are dipping your toes into the crypto trading space to test it out? And just how often will you be checking your investments – daily or hourly? Nearly half of investors check their performance at least once a day, but excessive monitoring of short-term returns can lead to knee-jerk reactions which, in turn, result in impulsive decision-making that doesn’t lend itself to letting investments and the money being traded grow over time.
Research shows that the more frequently investors monitor their portfolio, the riskier they perceive investing to be – this is also known as myopic loss aversion: When investors constantly check their investments, they become more sensitive to losses than to gains. Investors should monitor their trades as often as they can or want to – no one way or the other is better.
Monitoring your investments as little as possible works for some trader types because the more frequently they monitor their portfolio, the more likely they are to see a loss since the last time they checked. But for others, if they don’t check frequently after investing in volatile digital assets then there’s a strong chance they may lose a lot of money as those sort of slightly riskier investments could drop very quickly. How often to monitor your portfolio is as different for traders as their own individual risk appetite and risk tolerance.
The most important point when it comes to how often to check your investment is if you take on a high risk investment, you need to check it more regularly. But, even more important than that, is to always ensure that you invest only after you’ve assessed and analysed your risk appetite, and risk tolerance. Your trading options should always match your current risk tolerance levels, but setting take profits and stop-losses and using automated trading tools can help minimise risks.