If you’re reading this, the cryptocurrency bug has somewhat bitten you. And that’s great! But does the idea of trying to invest in a volatile environment give you pause? It might be for a good reason.
While many have succeeded with cryptocurrencies, there is no guarantee that these investments will pay off for everyone. Given the volatility in the space, it can be tricky to know how to approach investing in cryptocurrency successfully.
Thankfully, some basic strategies can help you navigate hedging with options against the risk of a significant loss. There’s no guarantee, but that’s true for any investment.
First, understand that investing in cryptocurrency is not like investing in a traditional stock or index fund. You aren’t buying shares in a company and hoping it performs well enough to make money. Instead, you’re buying tokens or coins with a specific purpose within a network and ecosystem (or they may be intrinsically worthless).
‘But what if I lose everything?’
The best thing you can do is to understand that cryptocurrency investing is more akin to gambling than traditional investing. These are speculative investments that involve risk; and as such, you might incur a loss. This can be hard on the ego, but it’s a reality of investment. There’s no going back from an investment once you leave the trading floor; people get burned by investments all the time and that is why hedging with options is necessary.
Hedging Strategies That Traders Can Use To Mitigate Risk
Here are a few options for investors who want to hedge against risk:
1. Use dollar-cost averaging
This simple strategy helps you spread out your buying and selling over time. In this strategy, you use a set amount of money to buy cryptocurrency on a set schedule.
For example, you could use $1,000 monthly to invest in ETH at the start of each month. If ETH prices rise and fall during the month, this approach can help you protect yourself against volatility.
Traditionally, dollar cost averaging is used to smooth returns and manage downside risk. It’s a conservative strategy that may not be for everyone, but it can help you maintain a healthy dose of realism about the market.
2. Spread Your Investments Around
Other investors choose to diversify their Portfolio by spreading their investments around to mitigate risk. For example, you could buy one ETH, one BTC, and one LTC. If the price of ETH drops, it might positively impact the other two cryptos so that your portfolio doesn’t take too much of a hit. These are all examples of hedging in practice, but every investor will have different needs and goals. Do what works for you.
You may not be comfortable with more than one token, but this strategy can work for some investors. When buying a single token, the implication is that you believe it to have the most potential. Others may choose to spread investments across several different coins and use these as hedging strategies. Whatever your approach, know what makes sense for your goals and comfort level.
3. OTC Options Trading
For more advanced traders, hedging cryptocurrency is an essential skill for managing risk. There are numerous options for trading cryptocurrency over-the-counter (OTC). These are all confidential setups that use financial instruments to protect against risk. For example, an investor could sell short or buy put options for the currencies they are interested in.
Options trading is a bit more advanced but it can be a critical part of hedging cryptocurrency and managing risk. The cryptocurrency market is still in its infancy, so there aren’t too many options. Still, things will continue to evolve over time as the market matures.
If you buy put options for Ethereum, for example, then you have the right to sell ETH at a certain price by a specific date.
So, if ETH is falling in price, you could use your call options to sell it for a profit. This way, you can reap some of the rewards of crypto investing without taking on all the risk. These hedges can be difficult to understand at first, but once you become more familiar with trading and how options work, this strategy becomes much clearer.
4. Short Selling
Short selling is another way to hedge against risk. When you short-sell cryptocurrency, you’re actually buying the tokens and selling them with the expectation that they will fall in value. In other words, you’re betting that the price will drop.
This strategy may sound strange to some people, but it has a legitimate purpose behind it as well. In other words, if you think Bitcoin could drop before the year’s end, you could buy BTC and then sell it short so that others don’t get hurt by this decline in value. If BTC rises before your hedge expires, then you make a profit.
5. Use Futures Contracts
Many investors turn to futures contracts to manage risk, particularly when they’re willing to buy or sell cryptocurrency over long periods.
Futures Contracts are a type of derivative that allows you to trade a cryptocurrency contract without actually owning it. You have the right but not the obligation to buy and sell a particular amount of cryptocurrency by an agreed-upon date. This is another more appropriate strategy for advanced traders, but it can be used as part of a forward-looking hedging strategy. The most popular futures contracts for investing in Bitcoin are known colloquially as XBT contracts, which refer to Bitcoin futures contracts settled in USD designed by CBOE on the CFE exchange under the ticker BTC.
Summary
There are many ways to invest in cryptocurrency to reap the best results with the lowest risk. In this article, you have discovered five unique hedging strategies to mitigate risk, but there is still much more to know. Before you can implement these strategies, you must first identify the right trading platform for your needs and gain an understanding of investing for beginners.
