It’s no secret that trading cryptocurrencies can be a risky investment. Market declines are inevitable. As a trader, you need to find ways to protect your investment from risk, which is where cryptocurrency hedging strategies come into play. The hedge covers the opening of positions in opposite market directions to reduce the risks and effects of market fluctuations.
But what is a hedging strategy? What are the risks of cryptocurrency? How to apply risk hedging strategies to cryptocurrency? Is the hedge 100% risk free? If these questions seem confusing, you’ve come to the right place. This article explores everything you need to know about security. We’ll also show you four encryption security strategies that you can easily implement. Indeed, the introduction of crypto protection tamed the crypto bubble in 2018.
What is a hedging strategy?
According to Investopedia, hedging is an investment to reduce the risk of adverse changes in the prices of an asset. Hedging strategies allow investors to use more than one simultaneous bet in opposite directions to minimize the risk of drastic losses.
Hedging has long been a financial market strategy as a type of risk management technique for cryptocurrency traders. It allows you to maintain stable value for your investments (without a significant return) in adverse market conditions.
While hedging cryptocurrencies protects your assets from adverse market changes, it also limits the potential profit you can make from your cryptocurrency investment. However, for risk-averse cryptocurrency traders, this is a better option than losing all of one’s assets due to unfavorable price swings in the cryptocurrency market.
Types of cryptocurrency risks
Like the foreign exchange market, the cryptocurrency market has similar risks: volatility risk, regulatory risk, transaction risk, and leverage risk. Cryptocurrency risks (like most financial instruments) are usually caused by the volatility of these currencies. Cryptocurrency trading is primarily speculative. Therefore, you should understand these risks before trading.
Cryptocurrencies are volatile
Since cryptocurrencies are highly volatile, sharp and sudden price movements often occur when market sentiment changes. It is common for cryptocurrencies to fluctuate rapidly in value, by hundreds or even thousands of dollars at a time.
In January 2021, Dogecoin increased by more than 800% in 24 hours and the next day the price dropped by more than 500%.
They are not regulated
While governments and financial institutions are starting to take notice, there is still uncertainty around things like whether they are classified as a commodity or virtual currency.
The lack of regulation limits protections for sellers and buyers, forcing investors to rely on trends, individuals and personal experiences when making investment decisions.
Communication errors and delays in processing trader orders can cause huge losses to cryptocurrency traders. It is therefore very important to choose an exchange that can handle a high number of transactions per second (TPS). For example, Bybit leads the cryptocurrency industry by processing up to 100,000 TPS. It also provides compensation for crypto traders.
Take advantage of the risks
With small margin deposits and collateral, traders can enjoy high leverage. Investors should be careful when using aggressive leverage, which can magnify losses under adverse conditions.
Now that we’ve covered cryptocurrency risks, let’s take a closer look at how to hedge cryptocurrency risks.
The golden rules of hedging
If you are too concerned about the risk to your position, closing it completely or reducing its size is a safer option. However, hedging can be a useful strategy if you want to preserve your cryptocurrency holdings and create neutral exposure. Here are some principles to keep in mind before applying security strategies:
- Opposite position: the rule is simple. The trader has to enter a position which is the opposite of his current position. For example, if you expect the price of a cryptocurrency to rise, you should take a long position.
- Evaluating Liquidity: Traders and investors examine the liquidity of a new asset to determine market integrity, speed of transactions, and market fluidity so traders can quickly convert their assets into cash without excessive risk reductions. price.
- Diversification: It is an open secret that diversification is one of the best money management techniques available to traders and investors. You can open multiple positions in Bitcoin (BTC), Ethereum (ETH), Chainlink (LINK) and many other tokens to build a well-diversified portfolio made up of derivatives.
Types of protection strategies
Short selling means selling an asset when the trader believes the value of the investment will decrease. As a trader, you can expect to make a profit by buying back cheaper or taking advantage of the difference. Short selling cryptocurrencies protect against long exposure.
According to Investopedia, short selling allows investors to hedge against the risk of long positions in the same or related securities.
Shorting generally increases the complexity of the encryption. Therefore, be careful with this tactic if you are selling cryptocurrencies for hedging or speculation. You can shorten cryptocurrencies in a number of ways, including:
- Margin trading where you can borrow from a broker to trade. Exchanges that allow margin trading also provide leverage, which can magnify potential profits or losses.
- A traditional short sale where you borrow from a broker, credit platform or third party and then sell the cryptocurrency and buy it back at a better price.
In finance, the term futures refers to an agreement to sell or buy an asset at a specified price on a specified future date. Since it has its own secondary market, futures can be sold before the agreed date. This increases liquidity for investors and entrepreneurs. Futures contracts are part of a large class of trading instruments known as derivatives, which includes CFDs (Contracts for Difference), options and swaps.
Cryptocurrency futures operate on a similar concept. Due to the volatility of cryptocurrencies, most traders buy when prices are low and sell when prices are high. However, such sales and purchases can cause investors to miss out on potential profits.
Cryptocurrency futures allow you to keep your positions open, maximizing returns from your cryptocurrency investments. Today, CME offers several Bitcoin futures with different expiration dates, for example in the Bitcoin Futures calendar. All contracts are payable in US dollars on the expiration date.
Futures contracts hedge your investment or lock in your profits in volatile markets like cryptocurrencies. They are ideal for investors who want to protect their exposure to the cryptocurrency market for a reasonable period of time.