Trading Bitcoin and other cryptocurrencies can be a very profitable endeavor. Of course, it could also go horribly wrong. Using traditional trading tools sometimes works out for the best, but in a lot of cases, it is a losing move. The stop-loss order is perhaps one of the most common tools used to limit one’s downside when investing in traditional assets. When it comes to trading Bitcoin and altcoins, however, it can be disastrous.
What Is a Stop-Loss Order?
Put simply, a stop-loss order is one which is placed to sell an asset when its price reaches a certain level.
These orders are intended to limit the loss of a trading position in case one’s prediction fails to play out. A lot of traders tend to associate this type of order with long positions, but it could be used to protect a short position as well.
It’s a very commonly used tool, and it’s one which takes the emotion out of trading decisions. By setting a stop-loss order, you shield yourself from situations where you’re uncertain as to whether to get out of a losing trade.
Why Do They Work in Traditional Markets?
Traditional markets which aren’t as volatile as cryptocurrency are where stop-loss orders shine. As we said, this type of order takes the emotion out of trading.
For example, if you’ve entered a position which isn’t going as planned, the stop-loss order will be triggered when the price reaches a certain point. Usually, investors calculate their risk and determine how much they are willing to lose in case the trade doesn’t go their way.
When the markets are less volatile, the price doesn’t fluctuate as much. Hence, it makes sense to get out of a losing position and re-think your entry points and overall strategy. When the markets are volatile, however, things are very different.
When a Stop-Loss Leads to Disaster
When markets are volatile, it is entirely possible for the price of an asset to swing violently. Such is the case with Bitcoin. It is not uncommon for its price to drop by 5% only to recover in a few moments.
This goes for other cryptocurrencies as well. The entire cryptocurrency market is relatively small compared to more traditional ones. This is why market manipulation is not out of the question.
Heavy Bitcoin holders, or “whales”, can easily move the price in the desired direction in order to profit. For instance, a whale could go to a spot exchange and begin dumping his or her Bitcoin to drag its price down, while also holding a highly leveraged short position to profit from the downtrend on an exchange that allows margin trading. Then, once the price is down, the market quickly recovers and the price goes back up.
In that situation, a stop-loss order could be disastrous because it will sell your position at the trigger price. This way, you will be out of the trade before the price recovers, which usually happens very quickly, especially with Bitcoin.
To give you a very fresh example, this very thing happened less than a day ago.
As you can see, yesterday the price of Bitcoin dropped from about $9,520 to around $9,080 very quickly. That’s roughly a 6% quick drop in value, which is definitely significant, given the short time frame. However, Bitcoin recovered almost immediately in a particularly quick uptick.
So, if you had entered a long position and set a stop-loss anywhere between $9,500 and $9,080, your position would have been closed and you wouldn’t have been in it for the recovery. You’d have ended up losing despite setting the right position (longing the market).
And that’s not a one-off scenario: the past year’s Bitcoin chart displays several such well-planned moves.
What’s the Solution?
Instead of placing actual stop-loss orders when trading Bitcoin, sometimes it may be more appropriate to have one set in your mind. This way, you will have the opportunity to assess the situation and determine whether or not it’s worth exiting your position for a loss, without actually setting a stop-loss order that can be forced closed like in the above scenario. However, keep in mind that you will need to check the market occasionally to monitor the current price.
Cryptocurrency charts by TradingView. Technical analysis tools by Coinigy.