Surely the question “HODLn or Stop Loss?” one of the most contentious and difficult questions in the crypto industry. Many would phrase the question differently, “HODL or trading?”. In this article we will explain the possibilities associated with a stop loss and the advantages and disadvantages associated with it. Of course, in this article we also explain the basic terms and how a stop loss works on a corresponding stock exchange for beginners in the industry. Not every provider in the crypto space supports the stop loss function. As a rule, this setting only works for “real” exchanges.
What is HODLing?
Most users in the industry are familiar with the term “HODL”. It essentially describes a long-term investment strategy. Investors who follow this strategy decide to “hold” their investment through all market phases. You could also compare the HODL principle with a classic value investing strategy. When HODLing, neither sells in high-risk phases nor realizes profits in bullish phases. The investor assumes a long-term increase in value and a secure intrinsic value of the “investment”.
Stop Loss and how it works
The “Stop Loss” is a trading function of classic exchanges and crypto exchanges. The Stop Loss is a tool that traders work with on a daily basis and set the so-called “Risk to Reward” ratio. This is about protecting the capital employed. If a trader opens a trade with the investment hypothesis of a rising price, he must also expect failure. In the event of a price movement contrary to his assumption, the trader limits his loss with a stop loss.
A simple example: A trader buys a bitcoin at a price X. He now sets a stop loss (sell order) at 1% below the buy price and a sell order (take profit) at 3% above the buy price. With this strategy, the trade has a risk to reward ratio of 1 to 3.
This mechanism can not only be used as a trader, investors with a large portfolio also use this strategy. As a rule, however, the main difference here is the risk-to-reward ratio.
An example from an investor’s point of view: An investor buys 20 Bitcoin at a price X. At 15% below its entry price, the investor places a stop loss (sell order). With this option, the investor protects his capital at least up to a maximum of 15% loss. Now the price rises by 20% and the investor no longer places his stop-loss order in the loss but shifts the order into the profit area and secures, for example, 15% of the profit. The stop-loss order is therefore set 5% below the current rate and adjusted regularly. So if the price continues to rise, the investor continues to benefit from the increase; if the price falls, the investor secures his profit.
So much for the theory, unfortunately the topic of stop loss has some pitfalls that need to be considered. In the following, we will address the topic of taxes, volatility and how the stop-loss order actually works.
Stop Loss = Market Order! Beware of Spread!
There are two types of “orders” on a stock exchange. The so-called “limit order” places an order in the order book. Traders who place a “limit order” write their buy and sell orders in the order book and are called “market markers”. As a rule, market makers pay fewer fees than market takers. (Distinction between “maker fee” and “taker fee”). Takers are participants who execute orders directly against the order book.
Bitfinex order book
A stop-loss order is usually a “market order”, so it costs more fees than a limit order and the risk of a spread is very high with this order. The spread is the discrepancy between the price offered and the price demanded.
An example: The trader now wants to sell a bitcoin at the current price and decides on a market order. Unfortunately, at the last traded price, only someone is offering 0.5 Bitcoin. The remaining 0.5 Bitcoin are offered and executed at the next best price from the order book.
As a rule, the larger the quantity sold, the larger the spread and the effect of high fees. So if the trade sells one bitcoin, the spread could be maybe 0.1%. However, if he sells 100 or 1000 Bitcoin and the market is currently in a weak phase or in a downward movement, a spread could also be 1-5%. So you might end up losing 16-20% with a 15% stop loss.
If you still have questions about this topic, you are welcome to ask your questions in our community under the Stop Loss on Portfolio, Pros and Cons post
The issue of tax exemption
Without wanting to delve too deeply into the subject of taxes, many German investors in the crypto space opt for a minimum holding period of one year for their crypto investment. The goal is tax exemption after one year as a private investor. However, a stop loss on the “fresh” portfolio is a problem in terms of the holding period. At the moment of sale before the end of the holding period, the tax exemption expires. Of course, this is not a problem in the case of losses, but if you put your stop loss in profit, taxes will be incurred at that moment. (No tax advice!).
So the trade-off between locking in profits and holding onto bullish markets without locking is a very personal decision. Especially with cryptocurrencies, stop losses are constantly in danger of being executed due to the high volatility. Calculate the tax burden in your profit calculation, at least in the case of a stop loss in profit. In some market phases it can really make sense to take profit with taxes rather than wait for the end of the tax exemption and then find yourself in the bear market with a 50% loss.
From own experience
At this point, as an author, I would like to report a little about my personal experience on the subject of Stop Loss. At the end of 2021 at the time of the new all-time high, I looked at the history of the last few years. Typically, after each all-time high, there was a major correction. Since the cryptocurrencies are in a limited liability company, we unfortunately do not have the option of tax exemption. Nevertheless, this perspective is also interesting from the point of view of a private investor. I decided to place a stop loss order on my entire portfolio at 5% below the current price.
If the market continued to rise, I would have moved my stop-loss order at some point with the appropriate distance. However, the expected scenario occurred, the market made a massive correction, which is referred to as the “blow of top” on the stock exchange. My entire portfolio was stopped out. In the current market phase after a dump of sometimes 70-80% of some coins, I now strategically buy myself back into the market on a regular basis.
From my experience of the last 5 years in the industry, I can report that this strategy is also used by many large investors. So it’s not about constantly getting in and out of the market. It’s about safeguarding values with a sense of proportion. The difficulty here is the timing and distance for the stop loss and then getting back into it becomes even more difficult.
For most investors, the HODL strategy is a hassle-free solution, based on the belief in a long-term rising market, it also involves the lowest risk. However, if you manage to find a good stop loss and re-entry with a sense of proportion and a look at the most important market data, you can benefit greatly from this method. Of course, the old stock market adage also applies here: “Back and forth empties your pockets”.
Basically, trading your portfolio requires a lot of experience and should only be carried out by someone who not only understands the market but also the order form of the relevant exchange. A wrong click can cause a lot of damage here. So always test with tiny amounts before placing an order and check the result carefully.
If you have any questions about this post, please leave us a comment below this article and discuss the pros and cons with us