How Well Do You Know Your Trading Tools? - Manage Risk of Cryptocurrency Exchanges
Do you know every order type, tool, option, and derivative on your cryptocurrency exchange? Are you familiar with stop hunts, slippage, exchange stability issues, and the cost of fees in trading?
In this series, I’ve been hammering down some facts about all the dangers that prey upon you as a trader. We’ve now covered the importance of:
Managing risk in general
Third-party risk, which includes risk coming from the exchanges where you trade.
The risk of the unpredictability of the market itself.
Today we’re looking at some of the risks you can encounter while executing the trades themselves. These potential risks will, of course, depend on the exchange and the type of trading you do. One of the biggest differences stems from the type of market you trade, spot coins, commodities or stocks, or margin-based futures, a.k.a. leveraged trading.
The latter comes with a plethora of additional risks and dangers, so only trade with leverage if you know what you’re doing. And definitely not if your first question to anybody is, “What leverage do you use”!
Let's start with one giant pain in the ass of any crypto trader of the past few years:
Exchange stability.
You’ve not known panic until you have a giant position open on an exchange, in the middle of a market-wide panic drop, and no order to sell goes through!
All you see on your screen are error messages, connection issues, and order failure alerts. You keep pressing the buttons and keep setting up orders, but nothing goes through. You can even get locked out of the exchanges at the most inopportune times. Many, including myself, have lost lots of money in those types of situations. And while they are rare these days, mostly because I ran as far away from any exchange that does that to its clients, they can and do still happen in those most volatile moments in the market.
How can you protect yourself from these types of dangers?
Well, first and foremost, by researching exchanges and trading only on the most stable and safe ones.
There is no need to add additional risk to trading if there are better alternatives out there. Personally, I’ve found Bybit (my referral code: OP0JL) to handle the traffic in these critical situations best, so I trade there for the most part and stay far away from the likes of Bitmex, for instance, which was famous for its instability. I’ve also had problems with Binance and Kraken, but I’ve not been using these for a while now, so it’s quite possible that they all fixed their issues long ago. Do your homework and take into account the latest reports.
If you’re using an API-enabled trading application (like Coingy, for example), those same problems could be encountered there as well, inflated by potential exchange stability issues. Test thoroughly, and during or after such volatile moments, check if the data from API feeds is correct.
Did your orders go through?
Were there any problems and so on?
Is the API app showing the right data?
In the early days, when these problems were a very dominant nuisance, I would simply trade directly on the exchanges at those critical times. Better safe than sorry and whatnot.
The second most important thing you can do is to set up the desired orders upfront before these volatile moments in the market even begin.
That goes for entry orders and, more importantly, for exit orders (stops, take profit, sell…). Use orders like “stop + market buy/sell,” and in those conditions, avoid using limit orders for existing positions (stop loss, take profit) because the chances of the order not going through or getting jumped on account of lag are quite significant. For taking on positions, limit orders are generally good.
You should also have a plan B for your own technical side of things.
What will you do if your internet connection falls at the most problematic time?
Do you have a mobile access point ready and know how to use it?
What will you do if your computer crashes or simply dies on you, and you have to react fast in the market?
Do you have a backup computer, tablet, or smartphone set up to take over? You should.
Be prepared, don’t leave yourself exposed to silly problems that can be avoided! Control all that you can control.
Research your trading exchange thoroughly!
Familiarize yourself with the fee structure and the options available to you. What type of orders will you be using? When? Why?
Personally, I prefer getting into positions via the “limit order” and then setting a “stop market order” for my hard stop and a “limit take profit order” for closing the position in profit. Which option will you use as the trigger price (last, index, mark)? They all have their benefits and dangers.
When I was playing more with day trading, even entries had to be made with market orders, damn the fees, because I simply didn’t get any trades. The price kept running away from me. So this all depends on your trading preferences and style.
For the complete list from CoinTracker.io, click here.
Exchange fees.
If you’re a day trader and make lots of trades all the time, fees will be of greater concern to you. They add up really quickly and can completely annihilate your trading edge if you’re not careful.
If you’re more of a swing trader, you don’t have to worry about trading fees all that much apart from the funding fee when trading perpetual futures contracts (leveraged trading).
The simple rule of thumb is, if you plan to hold positions for longer than a few hours or days at the most, stick either to spot (buying actual coins) or futures contracts (quarterly, yearly…). Paying a funding fee every few hours adds up really quickly, especially in certain overwhelmingly trending conditions, where the fees go through the roof!
The danger here is, therefore, twofold, expensive fees and failure in executing orders. The most important thing to remember is to always use “stop market” orders for risk management! There is no point believing you’re protected by a stop order if one doesn’t execute!
In those most problematic places on the chart at those most important times, “stop limit orders” are useless. I can’t even tell you how many times I got screwed for not using a market order, trying to save on fees and avoid slippage. The market order closes your position at market price, whatever that price may be. The limit order, when triggered, only sets up an order to buy or sell at your predefined price, which may be misaligned with the current conditions. That can result in you either effectively market selling or your order getting canceled or jumped, depending on the exchange settings (“post only” option, for example) and the situation itself.
This brings us to the next trading execution danger:
Order execution slippage.
What is slippage? Let’s see how Investopedia defines it: “Slippage refers to the difference between the expected price of a trade and the price at which the trade is executed. Slippage can occur at any time but is most prevalent during periods of higher volatility when market orders are used. It can also occur when a large order is executed but there isn't enough volume at the chosen price to maintain the current bid/ask spread.”
Problems of damage incurred by slippage are more pronounced with traders who trade with bigger accounts, but they can be a problem for almost anyone if you trade in illiquid markets, of which there are plenty in the crypto space. I remember my humble self, being a bloody whale-like creature on the order books, when I was still playing with altcoins.
That caused a myriad of headaches and problems for my trading strategies. While buying on the way down, for instance, wasn’t such a problem, getting out of those positions, and selling my worthless coins when I wanted to, was almost an art form. A nerve-wracking one at that.
One had to do it really slowly and methodically in order not to scare off other traders and reverse the price heading. And I repeat, I am a small fish in a big pond and always was. The problem wasn’t my size; it was the lack of liquidity in the market.
In some moments, they simply dry up, and buyers can disappear from the order books really quickly when they get scared. There simply weren't enough buyers for my coins to take them off my hands when I wanted to unload. Sometimes that meant that I had to continually add and remove small orders, sometimes for hours at a time, in order to sell all I wanted to sell.
Know the liquidity limitations of your market and adjust your trading size.
If you find that you are one of these whales that seems to move the market or simply suffer a lot of slippage when executing large orders, here are a few pointers:
Distribute your orders among many exchanges and/many markets/coins…
Split your large order into many small ones to blend into the order books; never stick out unless that’s on purpose.
If you’re splitting your orders, don’t use the same amount on all of them, because that too will stick out in the order books. (example: 1 million USD order turned into 100 x 10,000 USD orders)
Stick to highly liquid markets that can handle your size (that’s what she said, ups).
Choose a higher time frame trading or investing that will give you more time and opportunity to buy and sell your portfolio.
Try out OTC trading and do a deal directly with buyers or sellers
Look for liquidity pools on the charts and try to get your orders filled there.
Slippage can be a problem in liquid markets as well if you’re trading on leverage. If, for instance, you’re a day trader or a scalper and trade really small moves in the market, say one or two percent per move, you might be using larger position sizes in order to make money from these tiny moves. I did that quite a lot, actually.
The problem of fees and slippage is very prominent in the world of day trading, with the potential to kill even the best-looking strategies. I got burned trading even the biggest altcoins this way because liquidity in those markets was way too unpredictable for profiting on these small moves. I also got my ass handed to me, trying to buy a panicking Bitcoin that slipped me for multiples of my assigned risk!
So how the hell do these big players manage to trade in these markets? Well, by using you, the small players, as liquidity providers, among other strategies.
This brings us to the next topic of discussion:
Stop hunts.
Large traders prey on smaller ones, not necessarily because of some nefarious intentions, although let's be fair, we’re all here to make money, not friends, but out of necessity. In order for some large institutional trader to buy or sell millions of dollars worth of crypto, he or she cannot simply press the market buy order because that would cause all sorts of havoc on the market.
So if Mr. Musk wants to buy 1 billion dollars worth of Dogecoin, he can’t just go to Binance and buy up all the coins from the market like a mere mortal.
He has to try to make the deal over the counter by finding direct sellers with large pockets, which is still the best way to go about it (OTC trading), or he has to cut that 1 billion dollar buy order into millions of individual smaller buy orders and spread them across the exchanges, in some predefined price range, where he’s willing to be the buyer.
He might also identify certain places on the charts, certain price points, where he has reasons to believe that there will be larger liquidity, enough for him to do his bidding. Those places are usually around more important support/resistance levels and more psychologically meaningful round numbers. Places then, where the majority of traders, buyers, and sellers want to do business for various reasons.
Now he could wait to see if the price gets to these places all on its own, but he is an Alpha male. He doesn’t like waiting, and he doesn’t like to leave things to chance. Standing in front of his mirror in the morning, he might even square up, squeeze his but-cheeks, and exclaim victoriously: “I am the market!”
Picture a cowboy herding his cattle to the slaughterhouse, if you will. A few large orders here, market sell a few million there, maybe call a friend at the news channel and feed him some FUD bullshit story, just to make a point. Don’t forget, our hero doesn’t concern himself with minor details, such as “the truth.” That’s for the plebs, he explains. Sometimes he has to work hard to get the desired effect, but other times the market is so close to these levels and his projected ideas that all he has to do is just push them over the edge. Go on Binance, for instance, and put up a 100 million USD sell wall or something. He could also just announce what he's doing if he has a large following, and people will be jumping on board.
So my point here is that when looking at the charts when scanning the order books, you cannot trust your eyes. Bigger games are being played all around you, and if you don’t learn how to recognize them, you will be the main dish every single time. Once you see these games, you cannot unsee them. Then it’s time to adapt and find a way to get around this problem.
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