How to hedge crypto
The concept of hedging has been around for decades. It is being used not just in cryptocurrencies but in every major segment of finance. Hedging allows an investor to secure a stable revenue out of their investments even during undesirable market conditions. Thus, if correctly applied, hedging can eliminate the uncertainty of investing in a cryptocurrency to a greater extent. But while it limits the potential losses, crypto hedging has some downsides too. Hedging can protect an investor's asset from adverse market fluctuations, but it will also limit the potential profits that the investor could have gotten.
But many swing traders and investors with substantial capital invested might agree to this risk-averse strategy rather than losing money in wrong trades. Hedging thus acts as insurance of a trade, which will be invoked if gone wrong. Why is hedging important in crypto?
Volatility For the most part, cryptocurrencies are volatile assets; they are unregulated and, at times, unstable. Therefore, even after charting on an asset perfectly and opening a trade accordingly, you might have to experience trend reversal in the opposite than expected direction. Stop loss is essential, but can they save you from heavy losses? As mentioned above, cryptocurrencies are fundamentally volatile assets, and even if the price action is going as planned, there could be stop hunting.
Stop hunting is a strategy that tries to force some market participants out of their positions by pushing the price of an asset to a level where many have chosen to set stop-loss orders. Bitcoin dominance Altcoins follow Bitcoin's price actions, i. But if a coin is nearing a breakout or has broken out due to some recent developments and Bitcoin dumps, that breakout would abruptly turn into a fakeout.
Top crypto hedging strategies As a trader, below are the four most popular strategies that can be used for crypto hedging against the market to secure your holdings. Short selling In short selling, traders take a position to short an asset when they believe that their spot holding will temporarily or for an indefinite amount of time fall in value. With short selling, traders can also sell their spot holdings and buy back when the price is lower, securing the gains and thus securing more buying power.
In other words, short selling allows investors to hedge against the downside risk of a long position in the same cryptocurrency or a related one. Basically, short selling in cryptocurrencies protects against long exposure. However, shorting might bring complexity to margin trading since increased borrowing power could raise your liquidation price. Futures Future is essentially a contract between two or more parties that agrees to buy or sell an asset in the future at a pre-determined and agreed-upon time.
In secondary markets, the futures contract can be sold before the agreed-upon date. Futures contracts are part of many trading instruments known as derivatives, including Contracts for Difference CFDs , Options, and Swaps. Investors can open a short position when they think a pullback is due; in secondary markets, they can open a short position, earn some capital and invest when the price is lower. Hedging encompasses opening positions in opposing market directions to reduce the risks and impacts of market swings.
But what is a hedging strategy? What are cryptocurrency risks? How to apply risk hedging strategies to crypto? This article will explore everything you need to know about hedging. In fact, the introduction of crypto hedging has tamed the crypto bubble in What is a Hedging Strategy?
According to Investopedia , a hedge is an investment that is made to reduce the risk of adverse price movements in an asset. Hedging strategies enable traders to use more than one concurrent bet in opposite directions to minimize the risk of drastic losses. Hedging has long been a financial market strategy as a form of risk management technique for crypto traders. It allows you to maintain a stable value for your investments without making a considerable return in undesirable market conditions.
While hedging crypto protects your assets from adverse market changes, it also limits the potential gains you get from your crypto investment. However, for risk-averse crypto traders, this is a better option than losing all their assets due to an adverse price fluctuation in the cryptocurrency market. Types of Cryptocurrency Risks Much like the forex market, the cryptocurrency market possesses similar forms of risks: volatility risks, regulatory risks, transactional risks, and leverage risks.
Cryptocurrency risks just like most financial instruments generally emanate from the volatile nature of these currencies. Trading in crypto is mainly speculative. Therefore, you must understand these risks before you start trading. Cryptocurrencies are Volatile Since cryptocurrencies are highly volatile, sharp and sudden price movements often occur as market sentiments change. It is common for the value of cryptocurrencies to quickly swing, by hundreds or even thousands of dollars at a time.
They are unregulated Neither governments nor central banks regulate cryptocurrencies. The lack of regulations limits the protection of sellers and buyers, leaving investors to rely on developments, individuals, and personal experience when making investment decisions. Therefore, it is vital to choose an exchange that can handle a large volume of transactions per second TPS. Leverage risks With low margin deposits and collateral, traders can enjoy a high degree of leverage.
Traders need to be cautious about using aggressive leverage that can increase losses during unfavorable conditions. Golden Rules for Hedging If you are overly worried about the risk to your position, closing it entirely or reducing its size is a safer option. But hedging can be a helpful strategy if you want to maintain your crypto holding and create a neutral exposure. Here are some of the principles you should bear in mind before applying hedging strategies: Opposite position: The rule is simple.
A trader ought to enter a position that is the opposite of its current position. Diversification: It is an open secret that diversification is one of the best money management techniques available for traders and investors.
Types of Hedging Strategies You can deploy crypto hedging strategies in a variety of ways. Here are the four most popular methods. Short Selling Short selling means taking a position to sell an asset when the trader believes that an investment will fall in value. You as a trader can look forward to making a profit by buying back at a lower price — or profiting from the difference. Short selling in cryptocurrencies protects against long exposure.
According to Investopedia, short selling allows investors to hedge against the downside risk of a long position in the same security, or a related one. Shorting typically adds complexity to crypto. Therefore, be careful with this tactic, whether you are shorting crypto for hedging or speculation.
You can short cryptocurrencies in different ways, including: Margin trading, in which you can borrow from a broker to make a trade. Exchanges that allow margin trading also offer leverage, which can increase potential profits or losses. Traditional short selling, where you borrow from a broker, credit platform or third party, and then sell the crypto and repurchase it at a better price. Downsides of Shorting The potential for loss is infinite when short selling.
So in order to avoid disastrous losses, a trader will set a stop-loss limit at his initial investment. Futures In finance, the term futures refer to an agreement to sell or buy an asset on a specific future date at a certain price. As it has a secondary market of its own, the futures can be sold before the agreed upon date.
This increases liquidity of investors and business owners. Futures contracts are part of a large category trading instruments known as derivatives , including Contracts for Difference CFDs , Options, and Swaps. Cryptocurrency futures operate under a similar concept.
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Scams Scams are everywhere and come in a variety of shapes and sizes. Small-time scammers could range from telling sob stories on social media and sharing a wallet address asking for donations to selling an unofficial NFT. Larger scams involve hijacking celebrity Twitter accounts to run cryptocurrency giveaway scams and smartphone SIM-swaps that give hackers access to sensitive account information so they can steal crypto assets from unsuspecting users.
Counterparty Counterparty risk is the risk associated with another trusted party being unable to fulfill contractual obligations related to an investment. An example of this is a cryptocurrency lender being insolvent and unable to return owed customer funds. The situation is all too familiar recently, with many cryptocurrency lending firms halting withdrawals and filing for bankruptcy.
Even banks themselves are only required to hold a small portion of customer funds. The rest gets reinvested by the bank for profits. Leverage Leverage risk is in reference to a powerful derivatives trading tool offered by margin trading platforms like Margex.
Leverage greatly amplifies the size of a position compared to what capital levels would normally allow. Profits are significantly increased but risk increases also. Leverage risk can be mitigated using stop-loss protection tools and preparing a trading strategy in advance with technical analysis. Short-Selling Shorting is the number one most popular cryptocurrency hedging strategy and one of the least complicated methods on our list.
It involves placing a short-sell order at key trend turning points, resistance levels, or following a confirmed breakdown from a chart pattern support. In a short position, a trader borrows a coin and sells it when the position is opened. When the trader closes the position, they buy back the coin and profit from the difference. The act of covering forced short traders to close rapidly in succession, creating a significant number of buy orders. Combined with natural buying of a breakout short squeeze can be especially powerful movements.
Crypto traders would use shorting as a hedging strategy to counter a spot position in the same cryptocurrency. Using an example of how to hedge Bitcoin, someone who holds BTC for the long-term might want to consider hedging spot positions with a short at resistance levels.
This hedging strategy works for any type of cryptocurrency. Staking Crypto Shorting cryptocurrencies does take some skill and requires supporting technical analysis. However, staking among the fastest growing crypto hedging strategies today due to the relative ease related to it. Staking involves locking up idle crypto assets in exchange for a variable interest rate called an annual percentage yield APY. Consider a situation where the market moves sideways for an extended period.
Profits are more challenging to come by at this time due to the lack of market direction. With staking, the crypto you hold can still make you more money. If you are holding crypto anyway, when the market is climbing your returns will compound due to most staking setups offering daily payouts in the cryptocurrency being staked. If the market is declining, your staking assets will earn an APY while everyone else is losing money. Staking has become more popular over the last several years.
Margex has also introduced an innovative trade while staking feature where users can utilize their staked crypto assets as account collateral for margin trading, enabling the ability to trade staked. Portfolio Diversification Portfolio diversification is the most complex of our cryptocurrency hedging strategies, because there are simply so many ways to approach it.
For example, buying NFTs could be considered portfolio diversification. If you believe that Dogecoin is a better payment currency than Bitcoin, consider hedging Bitcoin with a position in Doge. If Ethereum continues to struggle with the total number of TPS it can process, a position in Solana could perform well.
There are seemingly endless ways to diversify a crypto portfolio with other digital assets. However, because the crypto asset class is highly correlated, portfolio diversification more commonly involves hedging crypto with traditional assets or cash.
Moving into stablecoins that are pegged to the price of fiat currencies is also a wise hedging strategy during market downturns. Assets with low correlation to crypto include currencies, commodities, and precious metals like gold and silver. Investors can use technical analysis software with scatterplots to compare two assets and get a better understanding of what type of correlation exists. Derivatives Trading Derivatives trading involves trading different types of contracts that utilize the price of a particular asset.
Derivatives traders use a variety of methods to attempt to profit from normal price fluctuations. These more advanced methods of hedging crypto with derivatives include perpetual swaps, options, and futures. Different Types of Derivatives Hedging Strategies: The Ultimate Crypto Hedging Strategy Explained Trading derivatives like options, futures, and perpetual swaps is the ultimate crypto hedging strategy.
Here is everything you need to know about each type. Options An options contract gives the holder the right, but not the obligation, to buy or sell an underlying at a specific strike price on or before a certain date. In options, there are four basic ways to take a position: buying a call option, selling a call option, buying a put option, and selling a put option. When taking an options position traders can buy or sell to open and buy or sell to close.
Buyers and sellers make a profit depending on the type of the option: put or call. Using call options, buyers expect the market price of an underlying asset to increase beyond the strike price. Using put options, buyers are expecting the market price of an underlying asset will decline below the strike price, while the seller is betting it won't.
In options, the strike price is a fixed price at which the options trader can buy, or sell, the underlying asset or cryptocurrency. If the spot index price is the same as the options strike price, then there is zero intrinsic value of the contract. If an options trader is incorrect, since there is no obligation to exercise the contract, there is no substantial loss associated with the trade.
In exchange for the lack of risk on the backside of the trade, options traders pay a premium to open the options contracts. Options sellers who offer options to collect a premium are also referred to as options writers while buyers of options are called options holders. Options writers are also sometimes called grantors. The Greeks are: vega, delta, gamma, theta, and rho. Theta is a measure of time decay and its impact on an option the closer it gets to its expiration date.
Rho measures how much the price of an option should rise or fall per one percentage point change in the interest rate. Not only are options a way to spot hedge crypto or speculate, large firms who derive their revenue from cryptocurrencies like Bitcoin can use options as an insurance policy. For example, Bitcoin miners regularly hold BTC.
Their entire business model depends on Bitcoin and business revenue performs best when Bitcoin is in a bull market. Such a business can buy a put option to generate ROI from the trade that offsets any decline in revenue.
Futures By definition, futures are a financial contract to buy or sell in the future between two parties. Futures are derivative financial contracts which obligate the buyer to purchase an asset or the seller to sell an asset at a predetermined future date and set price. Futures typically rely on a price index of the underlying asset. Bitcoin futures and Ethereum futures have become incredibly popular as the asset class gains wider acceptance. Futures allow investors and traders to gain exposure to these crypto assets without owning the underlying asset.
Futures let traders also speculate on the future price of any cryptocurrency, hence the name. Futures can be settled in cash or in the underlying asset itself. Futures also allow investors to hedge spot positions of the same asset. Instead, they can hedge these spot positions with a short futures position.
Futures offer a number of tax benefits, in fact. Futures are typically listed by their expiration month. Unlike options which include time decay and eventually become worthless, futures must be settled by the buyer and seller. Perpetual Swaps Unlike options and futures trading, perpetual swaps never expire. Both big and small factors can cause inflation in an economy.
How does Hedging crypto works against inflation? In a perfect world, a hedge against inflation should gain value even as the buying power of fiat currency goes down. Throughout history, gold and real estate were common ways to protect yourself from inflation.
During inflation, these assets usually kept their value or even went up. By putting your money into these assets, you can keep your savings from losing value due to inflation. But investors have been less and less interested in gold over time. It is also very hard to transport and store. Even real estate has been hurt, especially since the market crash of People had to look for other assets that could protect them from inflation because traditional options were no longer as good as they used to be.
Indeed Hedging crypto works very well. So, Enter Bitcoin! How does bitcoin serve as a hedge against inflation? Bitcoin is a good way to protect yourself from inflation because there are only so many coins. Since then, about 19 million coins have been made, so only 2 million more need to be made. By doing so, a new blockchain would be made. Also, Bitcoin is much easier to move around than gold. It can be sent in a matter of seconds from one part of the world to another.
It is also available to anyone with a smartphone and internet access.
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These more advanced methods of hedging crypto with derivatives include perpetual swaps, options, and futures. Different Types of Derivatives Hedging Strategies: The Ultimate Crypto Hedging Strategy Explained Trading derivatives like options, futures, and perpetual swaps is the ultimate crypto hedging strategy.
Here is everything you need to know about each type. Options An options contract gives the holder the right, but not the obligation, to buy or sell an underlying at a specific strike price on or before a certain date. In options, there are four basic ways to take a position: buying a call option, selling a call option, buying a put option, and selling a put option.
When taking an options position traders can buy or sell to open and buy or sell to close. Buyers and sellers make a profit depending on the type of the option: put or call. Using call options, buyers expect the market price of an underlying asset to increase beyond the strike price. Using put options, buyers are expecting the market price of an underlying asset will decline below the strike price, while the seller is betting it won't.
In options, the strike price is a fixed price at which the options trader can buy, or sell, the underlying asset or cryptocurrency. If the spot index price is the same as the options strike price, then there is zero intrinsic value of the contract. If an options trader is incorrect, since there is no obligation to exercise the contract, there is no substantial loss associated with the trade.
In exchange for the lack of risk on the backside of the trade, options traders pay a premium to open the options contracts. Options sellers who offer options to collect a premium are also referred to as options writers while buyers of options are called options holders. Options writers are also sometimes called grantors.
The Greeks are: vega, delta, gamma, theta, and rho. Theta is a measure of time decay and its impact on an option the closer it gets to its expiration date. Rho measures how much the price of an option should rise or fall per one percentage point change in the interest rate. Not only are options a way to spot hedge crypto or speculate, large firms who derive their revenue from cryptocurrencies like Bitcoin can use options as an insurance policy.
For example, Bitcoin miners regularly hold BTC. Their entire business model depends on Bitcoin and business revenue performs best when Bitcoin is in a bull market. Such a business can buy a put option to generate ROI from the trade that offsets any decline in revenue. Futures By definition, futures are a financial contract to buy or sell in the future between two parties. Futures are derivative financial contracts which obligate the buyer to purchase an asset or the seller to sell an asset at a predetermined future date and set price.
Futures typically rely on a price index of the underlying asset. Bitcoin futures and Ethereum futures have become incredibly popular as the asset class gains wider acceptance. Futures allow investors and traders to gain exposure to these crypto assets without owning the underlying asset. Futures let traders also speculate on the future price of any cryptocurrency, hence the name.
Futures can be settled in cash or in the underlying asset itself. Futures also allow investors to hedge spot positions of the same asset. Instead, they can hedge these spot positions with a short futures position. Futures offer a number of tax benefits, in fact. Futures are typically listed by their expiration month.
Unlike options which include time decay and eventually become worthless, futures must be settled by the buyer and seller. Perpetual Swaps Unlike options and futures trading, perpetual swaps never expire. Since the contracts never settle, derivatives trading platforms utilize a funding rate to ensure the contract price and spot price stay relatively similar and converge regularly.
When the contract price is trading at a rate higher than spot price, the contract is trading at a premium and longs must pay shorts a funding rate. When the contract price is trading at a rate lower than spot price, the contract is trading at a discount and shorts must pay longs a funding rate. Since the funding rate is essentially a periodic rate paid to traders for holding positions, a high funding rate could encourage more traders to go long or short, which reduces the premium or discount.
Funding rate can also put pressure on one side of the market to close and can impact trends at decisive moments. In more simple terms, the funding rate helps keep the market in balance. Perpetual swaps let traders hedge spot crypto holdings or speculate over cryptocurrency price action. The Margex margin trading platform offers perpetual swaps on Bitcoin, Ethereum, Ripple, Litecoin, and other popular cryptocurrencies.
The next section will walk you through how to use the platform to hedge crypto using perpetual swaps short positions. Follow these four simple steps with supporting examples. Reversals commonly appear at key resistance levels and are an ideal place for a market entry. Step 2 - Look for supporting bearish signals such as doji patterns or bearish divergences. At this point, place a short-sell order to hedge your crypto holdings using perpetual swaps.
Step 3 - Place a stop loss order above the highest candle prior to the reversal. This prevents significant drawdowns from occurring if the market moves against your position. Step 4 - Plan ahead to take profit at key support levels. Congratulations, you have successfully hedged crypto! Due to the sheer variety and the complexity, we have prepared this list of commonly asked questions about crypto hedging strategies.
How to use crypto hedging to minimize trading risks? There are many ways to hedge crypto effectively and use the crypto hedging strategies to protect capital against loss and increase profitability during market downturns. Oftentimes, doing so is enough to offset losses associated with declining spot asset values. Common crypto hedging strategies include staking, portfolio diversification, or derivatives trading tools like options, futures, and perpetual swaps.
How to start hedging cryptocurrencies? Anyone can begin hedging cryptocurrencies immediately using Margex perpetual swaps. By going short Bitcoin, Ethereum, Ripple, Litecoin, and others, crypto traders and investors can hedge spot positions in crypto.
For other alternatives, always do your own research and stick with trustworthy and secure platforms like Margex only. No crypto hedging strategy is entirely risk free, even though these concepts are designed to reduce the risks associated with cryptocurrency exposure. When using Margex perpetual swaps to hedge crypto positions, users get access to risk management tools like stop loss orders to limit unwanted losses if the market moves against the position.
Risk varies across each unique crypto hedging strategy. What is the purpose of hedging crypto? Hedging crypto is done for the sole purpose of counteracting the risks and losses associated with cryptocurrency spot exposure. Cryptocurrencies are volatile and can lose value in an instant. While crypto spot prices are declining, a hedge short position with Margex can keep profits rolling and protect capital by offsetting losses associated with volatile crypto market drawdowns.
Is hedging a good strategy? Hedging is a great strategy when it comes to cryptocurrencies specifically. Stock, commodities, and currencies traders all use hedge positions, why not crypto? Cryptocurrencies can decline faster than most other asset classes due to the speculative nature and strong trends related to emerging cryptocurrencies. By going short, traders can earn profit while the market is falling, helping to keep a portfolio in the green overall despite assets dropping in value.
How do you benefit from hedging? Investors and traders can benefit from hedging in a variety of ways. For example, if hedging crypto by staking, the holder can compound returns with daily staking payouts directly to a staking balance. Going short an underlying asset you hold a spot position in can also protect capital and generate profits. When prices go up, people have less money to buy things. Because of this, you now need more fiat currency to buy goods or services that you could get for less in the past.
One example is that a chocolate bar that cost 20 rupees two years ago now costs 30 rupees. This is because of rising prices. Both big and small factors can cause inflation in an economy. How does Hedging crypto works against inflation? In a perfect world, a hedge against inflation should gain value even as the buying power of fiat currency goes down.
Throughout history, gold and real estate were common ways to protect yourself from inflation. During inflation, these assets usually kept their value or even went up. By putting your money into these assets, you can keep your savings from losing value due to inflation. But investors have been less and less interested in gold over time. It is also very hard to transport and store. Even real estate has been hurt, especially since the market crash of People had to look for other assets that could protect them from inflation because traditional options were no longer as good as they used to be.
Indeed Hedging crypto works very well. So, Enter Bitcoin! How does bitcoin serve as a hedge against inflation? Bitcoin is a good way to protect yourself from inflation because there are only so many coins. Since then, about 19 million coins have been made, so only 2 million more need to be made.
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