Cryptocurrencies can be highly volatile, subject to sudden, massive price fluctuations. Factors influencing volatility include but aren’t limited to market sentiment, regulatory developments, macroeconomic events, and technological advancements. You can consider hedging strategies and techniques to mitigate risk. Hedging protects your portfolio against short-term corrections in asset prices so you can maintain market exposure and enhance your overall success. Put simply, you can offset the losses generated by one trade by taking an opposite position in the same asset.
If you hold both Ethereum and Bitcoin, trading ETH/BTC allows you to quickly and confidently adjust your exposure based on your expectations of their relative exposure. There are thousands of crypto trading pairs. However, the ETH/BTC trading pair has historically had persistently high trading volumes and popularity among investors. You can benefit from an overperformance of one currency relative to the other, regardless of whether they’re trading in a bull market or a bear market. This allows you to make profits even if prices decline.
In The Crypto World, Managing Risk Is Of The Greatest Importance
The crypto market is relatively underdeveloped, so there’s the risk of an adverse change in price that can cause stress and financial losses. You can optimally hedge your crypto portfolio with predictable cash flow to minimize risk exposure and maximize returns, but consider the unique characteristics of the digital asset ecosystem. By doing your due diligence and implementing an action plan, you can navigate the crypto market with confidence. Without a risk management strategy, you waste all the time and effort that has gone into investing.
There Are Several Hedging Methods You Can Use To Mitigate Portfolio Risk
Undoubtedly, there’s a cost to hedging any investment, cryptocurrency or otherwise, yet the cost of doing nothing can be significantly higher. Selecting the appropriate strategy or technique depends on the specifics of your situation and your asset allocation. Without further ado, there are the most common hedging methods in the crypto market:
Margin Trading, Also Known As Leveraged Trading
Margin trading allows you to increase your buying power. You borrow funds from a broker to take larger positions than your available capital would normally allow. You can open a leveraged trade position that wagers on the possibility of a coin falling in value rather than rising. Margin trading supports various cryptocurrencies, such as Ethereum, Bitcoin, Tether, and more. And yes, you can trade ETH/BTC to amplify your profits. Using leverage to trade cryptocurrency typically involves using a Contract for Difference (CFD).
Short selling is an ideal strategy for long-term investors who choose to stick to the top cryptocurrencies by market cap as they can survive in the bear market. A well-executed trade can generate considerable returns. Still, if prices rise unexpectedly, the losses can exceed your initial investment. Monitor your positions closely and have strategies in place to minimize losses, such as stop-loss orders or custom margin call ratios (MCRs). Interest and borrowing fees can accumulate and eat into your profits.
Crypto Options
As the name clearly suggests, you have the option – but not the obligation – to buy or sell a given token, whether it’s Ethereum or Bitcoin, at a predetermined price and date. The put option protects against falling prices, while the call option lets you profit from price increases. Unlike spot crypto trading, which involves direct ownership of digital assets, options trading is a speculative bet on future price fluctuations. The value of an option tends to decline with time.
Find a reliable exchange that supports crypto options contracts. Make sure to compare fees, liquidity, and the supported assets. Since you’re a newbie, you can start with a single-leg option strategy, which involves a long or a short position. This straightforward method offers a foundation for understanding how options contracts work and how crypto market movements affect their value. You can acquire one or multiple call options. Careful planning is critical to optimize the trade-off between hedging costs and potential gains, guaranteeing the safety of your portfolio.
Diversification
Invest across different cryptocurrencies so your portfolio isn’t exposed to any single risk (or asset). Acquire tokens that serve a myriad of purposes, such as streamlining transactions, accessing services, or illustrating ownership of physical assets. Ethereum, for instance, can be used to develop decentralized finance (DeFi) apps or send money across different countries. While Bitcoin is an alternative to state-issued currency, Ethereum is a “Do It Yourself” platform that executes smart contracts that allow developers to leverage security, reliability, and accessibility.
80% of your portfolio should be in the largest, most established coins. You can invest in stablecoins (Tether or USD Coin) or large-cap cryptocurrencies (Ripple, Solana, Dogecoin, Cardano, etc.). 20% of your portfolio should be in mid-cap and small-cap cryptocurrencies. Examples are Polkadot, Litecoin, and Pepe. Diversification promotes long-term portfolio stability by limiting the effects of market volatility. It’s impossible to prevent losses, but having the right mix of assets can be helpful.
Futures Contracts
Futures trading involves trading derivative contracts of cryptocurrencies. You can speculate on the future price of digital assets without having to actually own them. It goes something like this: You purchase a handful of contracts that depict your stake (or lack thereof) in cryptocurrency. The futures contracts are settled in cash, and the funding rate determines the periodic payments made between traders who hold positions in the contracts.
Perpetual futures contracts are popular because they enable traders to amplify their positions beyond their initial capital. Additionally, they have no expiry date. Futures trading is much like margin trading, except that you can enter larger positions than your account balance. Disclosure: It involves substantial risk. Picking the right trade isn’t the most important thing. Stop-losses automatically close positions, keeping your investment within your risk tolerance threshold.
Closing Thoughts
Implementing hedging opens the door to several advantages. You can limit the impact of crypto market downturns, lock in profits during volatile periods, and stay invested in the market while protecting your capital. The way you hedge depends on the strategy you settle for. Take your time and choose wisely.
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