Never borrow to trade cryptocurrencies! |
Posted: March 16, 2018 |
I (Kirill Kretov) see many people with very limited financial literacy risking all their capital in trying to get rich in the extremely risky area of cryptocurrencies. I decided to write this short article and state three simple but important rules that should keep you away from serious financial trouble. Never trade with borrowed money (loan capital)!
The cryptocurrency market feels like a perfect opportunity to earn money. You can become rich simply by trading on exchange rate difference, by investing money in a relatively new coin, or by participating in the initial coin offering (so-called ICO). However, you always need to remember that these are extremely high-risk investments. The higher the short-term profit, the riskier the investment (a higher chance to lose money). That’s why I strongly advise to not involve any loan capital while working in this field. I recommend any newbie trader/investor to follow three simple rules:
• If you want to invest in cryptocurrency you need to only use the money available to you, without also taking out bank loans or borrowing money from your friends and family.
• Try to avoid margin trading while selling and buying assets on an exchange (or so-called leverage trading)
• You are the only one who can control your own funds, so use them wisely!
Let’s talk about each of these rules in more detail, and I will explain why it’s not recommended to use a loan capital.
Never borrow to trade
Don’t borrow money in a broad sense. It might seem like it’s an easy way to earn more – you take out a bank loan, invest in the cryptocurrency, and pay off the loan in full or part as you wait for profits from increasing rates or as a result of successful trading. However, the actual results are not as optimistic as they seem. The logic that people use who don’t want to evaluate risks and have a powerful desire to get as much money as possible is simple. For example, let’s imagine that an investor bought Bitcoin in September 2017 for $4,000 per coin and sold it in December 2017 for $19,000 per coin. This means that this investor gained 375% of the net profit, and so the risks that come with taking out a loan are eradicated because the investor managed to return their funds incredibly fast. However, we need to look at another example that works using similar logic. Let’s imagine that the same investor bought the cryptocurrency in December 2017, expecting its further growth. However, the rate of Bitcoin dropped at the beginning of 2018, and one Bitcoin was then only worth $6,500 in February 2018. As a result, the investor has now just lost two-thirds of his capital. This means if the investor took out a loan they would only be able to pay one-third of it back, landing them either in debt or challenges in how to pay the rest back. We need to make the following conclusions from these examples:
• Never use loan capital while investing in cryptocurrencies. This market is too young and very unpredictable for that. You need to remember that you can easily lose a significant part of your capital at any moment. You need to be clear about the risks of these investments.
• It’s virtually impossible to predict the growth or decrease of cryptocurrencies. There’s no doubt that there are special technical analysis tools, however, none of them (both tools and indicators) can give you a 100% guaranteed predicted outcome.
Rate changes usually happen in cycles, for instance, the price increase is followed by the decrease and vice versa. In most cases, investors have to wait for continuous depression in the market. That’s why I don’t recommend investing any money you might need to use in the near future. If you want to invest more money than you currently have, try selling unused items first (e.g. a second car, TV, gaming console or a collection of silver coins…), liberate some funds and invest them. But remember one thing – you should NEVER invest the money you plan to use for expenditures now or in the future. Stay away from margin-trading
As well as in broad terms, don’t borrow money in a narrow sense. The margin trading (or so-called trading with leverage) is also considered one of the most profitable trading tools for beginners. The leverage is just another type of loan, only offered by the exchange instead of the bank.
Let’s look at an example for this case. Let’s imagine that the trader is working with an exchange offering leverage of 5:1. This means that if the trader has $1,000 of personal money they can trade for $5,000. If the trader buys an asset and its price increased by 20%, without the leverage they will only make $200, but if he does have the leverage he will double his initial capital.
Sounds good, right? But let’s not forget the risks, which also increase. If the trader expects growth (while having a long position), and the cryptocurrency rate decreases by $100, the trader will lose five times more money. If the rate decreases by $200, the trader will lose the initial amount of $1,000! First, the trader will receive the Margin Call, which means that they have to add more money to the deposit to stay in the game (which might result in making some ill-considered decisions such as borrowing money from somewhere). Keeping the high volatility of the cryptocurrency market in mind, the chances of getting 100% of profits are equal to the chances of losing the entire deposit!
Of course, this example is simplified. Experienced traders can minimize their losses by using stop-loss tools in margin trading. However, they also face situations where they need to close the position earlier than planned, and for a lower price than they expected, resulting in a loss. On the other hand, the non-margin trader may simply wait until the undesired change of the rate is reverted (or buy more of the decreasing asset to lower buying average).
So, margin trading allows an increase in capital, but it still holds a lot of risks which is why this solution is more suitable for experienced traders who know how to evaluate the risks and potential profits. It’s highly unrecommended to use the leverage for those who are only just trying to understand all the trading process features. Newbies may not only lose their initial deposit, but they will also have no time to understand the entire situation and get valuable experience from their mistakes. Don’t trust others to trade for you
You are the only one who can control your capital. Nobody is responsible for your wealth but you! Most of us don’t have enough knowledge to make sound financial decisions, and so many of us sometimes think that it’s a good idea to let the professionals trade for us. There are many options available - give your money to trust management, ask a friend who’s a guru-trader, or work with a foreign foundation promising a high return on your investment. In any case, it will always be only you who is responsible for any losses, simply because it’s your money you’re working with.
Your risks increase when you give your funds to someone for them to use. You might get some profit in the beginning, but people who manage someone else’s money are tempted to trade more aggressively to gain short-term profit, and at any moment they might fail and make a huge loss for their clients. How is this possible? It’s down to their motivation -, these traders get a portion of your profits, that’s how they earn their money, but they don’t share your losses! This is why you need to learn how to plan and control everything on your own. To protect yourself from financial losses, you shouldn’t only focus on potential profits but you should think about all possible risks involved. Remember Murphy’s Law – "Anything that can go wrong, will go wrong."
If you want to use automated trading applications (trading robots), you need to remember that the algorithm has to be simple and understandable to you. All the publicly available self-learning solutions for automated market analysis - which only give profit by using patented strategies – is nothing but aggressive marketing (if not a complete fraud). In my opinion, the purpose of real trading bots is to assist the trader in automating some repetitive and routine tasks, but it’s the trader who makes key decisions and is responsible for all losses.
Keep in mind that all these recommendations won’t make you rich and double your capital in a matter of days, but they should protect you from significant financial losses and debts in case the market goes against your expectations. Plan your trading: create a clear strategy and follow it, and forget completely about instantaneous emotions and up-to-the-minute decisions that come with trading in this field. Control your own finances - only use the portion of your capital that you originally intend for trading and never exceed it. Never borrow money!
Other Cryptocurrency Trading articles written by Kirill Kretov: https://www.linkedin.com/pulse/trading-cryptocurrencies-part-1-introduction-kirill-kretov https://www.linkedin.com/pulse/trading-cryptocurrencies-part-2-exchanges-orders-basic-kretov https://www.linkedin.com/pulse/trading-cryptocurrencies-part-3-robots-kirill-kretov
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