Want to protect your portfolio? Be sure to manage the risk of so-called “flash crashes.”
These events, which coincide with sharp price declines, could wipe out your bitcoin holdings very quickly. GDAX and Kraken, which are both well-established cryptocurrency exchanges, have suffered flash crashes.
Fortunately, there are specific strategies you can use to manage the risk of suffering such losses.
The GDAX Flash Crash
The GDAX flash crash, which took place in June 2017, resulted in the price of alternative digital currency ether falling more than 99 percent from $319 to $0.10 after a trader made a multimillion-dollar trade.
This single transaction triggered many stop-loss orders, according to a GDAX blog post written by Adam White, a vice president at the exchange. These orders automatically sell securities once they reach a certain price in order to cap investor losses.
Executing these orders pushed ether’s price lower, and the digital currency’s continued losses caused the funds of many investors who were trading on margin to be liquidated, further exacerbating ether’s price drop.
Stop-Loss Orders
In order to protect yourself from situations like the GDAX flash crash, there are some simple strategies you can follow. First of all, make sure you know the costs and benefits of stop-loss orders, also known as stop losses.
While stop-loss orders can help you cap losses, they can also cause you to close out positions under less-than-ideal conditions. After ether plunged to $0.10 on GDAX, it quickly recovered, surpassing $300 the same day. (See our in-depth feature on Stop Losses.)
Buy and Hold
Altcoin prices are notoriously volatile, and one good way to manage this aspect is to simply buy and hold. That way, you can ride out any serious price fluctuations.
There are plenty of stories in the media of how investors could have made millions by purchasing bitcoin in its early days and holding it until it surpassed milestones such as $2,000 and $3,000.
However, it is important to keep in mind that if these investors had sold their bitcoin in the face of volatility instead of holding it, they may have failed to realize such generous gains.
Buy Limit Orders
In addition to protecting yourself from the potential losses associated with flash crashes, you can use buy limit orders, which purchase a security once it hits a specific price, to produce compelling gains.
For example, if bitcoin surpasses $1,000 and then falls below $500 — as it did in 2013 — you could generate a tidy profit by placing a buy limit order at $500.
By buying in at $500, you could enjoy a 100 percent return once bitcoin returned to $1,000. It bears noting that it might take a few years for the currency to reach this level, however.
Summary
Flash crashes can put your bitcoin holdings at risk, but by taking some simple steps, you can protect yourself from potential loss. For starters, knowing the ins and outs of stop losses and buy and hold strategies can help you manage risk effectively. By harnessing buy limit orders, you can potentially use flash crashes to turn a profit.
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