Avoid betting all your chips on a single thing. This is the most basic rule of investment and almost everyone has learned it. In a market as volatile as the cryptocurrency market, it is important to protect your interests. The right hedging strategies can help you cover crypto risks.
Hedging has been used in the financial market for a long. You can also use it to manage risk when trading in crypto. It helps you maintain a stable value for investments in unpredictable market conditions.
What is Hedging?
Hedging is a risk management strategy used to offset investment losses. It involves taking an opposite position to the current open position in a specific asset. It acts as a kind of insurance protecting you against the impact of an unexpected event on your investments.
Hedging’s objective is to reduce the financial impact and not prevent a negative event from happening. When hedging cryptocurrency, it is important to understand that it protects your digital assets against adverse market changes. However, it can also limit the potential profits you make from your crypto investment. It acts as an effective shield against losing all your assets from a negative price fluctuation in the crypto market.
The Need for Hedging Cryptocurrency
The cryptocurrency market has long demonstrated its highly volatile trait. Sudden and sharp price swings are common. Crypto traders usually see market volatility as an opportunity to make profits. In doing so, they easily expose themselves to the risk of recording massive losses.
There are even more reasons for hedging cryptocurrency. Cryptos were developed with the goal of decentralization. Since these digital currencies are not regulated, they are not guided by restrictions, guidelines, or requirements laid down for conventional financial institutions. This limits the degree of protection available to crypto traders. This further increases the potential of making big losses.
Cryptocurrency Risks
There are many forms of risks that affect the cryptocurrency market and those seeking to invest in Bitcoin and altcoins. These include regulatory, volatility, leverage, and transactional risks. Most of the crypto risks usually originate in the high volatility of these digital coins.
Cryptocurrency trading is mostly speculative in nature. This makes it so much more important to understand the involved risks before getting started.
i. Extreme Volatility
With market changes in market sentiments, cryptocurrency price movements occur suddenly and sharply. It has become quite common for these digital currencies prices to swing in an instant and by the hundreds or thousands.
ii. Transactional Risks
When it comes to crypto trading, it is important to select a reliable and top industry driving bitcoin capable of handling a large volume of transactions per second (TPS). Due to the very fast speed of crypto value movements, any delays in truncating orders or communication errors can easily translate into huge losses.
iii. Cryptos are Unregulated
Cryptocurrencies are not regulated by central banks or governments. More and more governments are not taking note and planning to bring these digital currencies under the ambit of the law. However, cryptos are still unregulated and thus buyers and sellers are not protected.
iv. Leverage Risks
Cryptocurrencies offer a high level of leverage due to low-margin deposits. However, you have to be careful about using aggressive leverage that can pile up losses when the conditions are not favorable.
Hedging Cryptocurrency Properly
Hedging can be an effective way to maintain your crypto holdings and reduce losses when the market takes a plunge. If you are a new cryptocurrency trader concerned about the risks and don’t have the time to research, it is recommended to choose the safer path and close your position or reduce the size.
It is recommended to follow these tips to implement hedging properly:
- Conduct research before implementing any hedging strategies. Learn to read, use, and analyze price charts.
- Learn to trade on a cryptocurrency trading platform.
- Practice your hedging strategy with the help of simulated trading.
- Start by edging small amounts of cryptos and gradually grow your positions.
When hedging cryptocurrency, it is best to position opposite the current one. This means taking a short position if you anticipate the price to fall and a long position if you think the price will increase.
As a cryptocurrency trader, it is important to understand that hedging cryptos is not a completely risk-free strategy. There are no guarantees which direction the price of a coin will move, no matter what the price charts signal. You should make the decisions carefully in choosing the coin that you want to hedge and which strategy to use for it.
