Every time I bring up the subject of hedging, questions abound. You are absolutely right to show your curiosity about this, because it is an indispensable strategy. It is even essential for any market participant if he wishes to maintain his profits both during small corrections of an uptrend and in times of crisis!
In this article, I will try to answer as many questions as possible on this subject that is close to my heart. Since I share my knowledge and experience on trading, whether on my blog dedicated to crypto trading or on my social networks with my free traininghedging is a central subject.
Hedging: Advantages and Disadvantages
Hedging is essential for any entity wishing to limit its losses, or to make profits when prices correct downwards. Here are some tips to familiarize yourself with the concept of hedging.
- Proper hedging of your risks allows you to stay long (anticipate the upside) during uptrends. Your portfolio becomes “neutral” because it also anticipates possible corrections. In this case, your profit curve stabilizes instead of going negative.
With hedging, you can keep your risky assets while protecting the absolute value of your portfolio.
- Hedging is not infallible. Some days, the upward swings in my portfolio are not significant. However, hedging my risky assets allows me to avoid large and regular downward fluctuations in a market as volatile as the crypto market.
During major turbulence, I remain calm, even impassive, and I “manage my risk”!
- The hedging strategy is similar to insurance, it is expensive and not always useful, of course, but it is essential in order to avoid ruin in the event of a disaster. Do not neglect the quality of your insurance!
- Hedging is insurance.
In the event of a significant fall in the price of my hedged assets or a crash in general, I try to limit the losses. In the crypto sector, good hedging is essential!
- If your hedging is successful, it is completely logical to reinvest the sums recovered in the assets that have suffered losses in order to maintain your coin portfolio at the same level of value in FIAT. You can also decide to recover part of your investment and thus reduce your exposure.
Hedging: 2 practical examples to illustrate my point
With the approach of the Merge and the speculative bubble that this event caused, I noticed significant movements during my technical analyzes suggesting an imminent drop in prices.
A classic example of hedging is exchanging ETH for BTC. Thus, when the BTC / ETH pair is on an important support or the price draws the beginning of an upward trend, you can exchange your BTC for ETH.
Conversely, when the price of ETH against BTC reaches resistance or draws the beginning of a downtrend, we can exchange our ETH for BTC.
On each of these transactions, we increase our number of units of ETH or BTC.
In both of these examples, you don’t exit, you stay invested. However, you reduce the risk thanks to the recurring cycles that are noticed in the BTC/ETH price.
Here, we were talking about simple hedging, because for practice, there is no need for derivatives which are sometimes more complicated to master than a simple purchase in spot trading. It will not be a particularly effective strategy either, but it is perfect for understanding the paradigm that the notion of hedging implies: reduce your risk as much as possible!
Advanced hedging: An example with derivatives
In a second example, I want to keep my ETH because I acquired it at a good price and I consider it a good long-term investment. However, this is not a good reason to remain passive and suffer the correction that follows the Merge head-on!
For this example, let’s take 1 Ethereum that I decide to hedge with put options:
- When I took a position, the price of 1 ETH is around $1800, so we can consider that my portfolio has a value of $1800.
- I buy an option valid until November, because I anticipate 2 scenarios:
- Ethereum price is rejected by the resistance at 2000 and reenters its range on the downside.
- The price falls after the merge.
I buy options for a value of $400 with a strike price of $2000 until the end of November. In this case, $400 is my maximum loss if Ethereum explodes higher and moves above $2000 and I don’t sell my options until November.
Note, however, that if this had been the case, I would continue to benefit from the rise by keeping my ether.
- If the price drops to $1300, Ethereum loses $500 in value.
- The Put Options I bought for $400 offset this value, because I can sell them back for $900 to make a profit of $500 on this position. So I have two choices:
has/ I decide to resell my entire puts: I get my $500 back and I take off my cover at 100%. In absolute terms, my capital remains stable for the moment, but it becomes vulnerable to the possibility of a new correction.
b/ I decide to recoup my losses, as we are hitting support, but I keep $100 of put options and remain partially hedged. It doesn’t matter if I choose a or b, I can then decide to reduce my exposure or keep it by making ether purchases.
I attach crucial importance to hedging because it is a strategy to remain active vis-à-vis my investments. This prevents me from suffering the damage of a bad economic situation while continuing to make profits.
On the contrary, hedging allows me to accumulate more while waiting for sunny days.
As you will have understood, hedging is an essential strategy for traders, but it is perfectly compatible with investing!
To learn more about trading, find me on my website or on my Youtube channel!
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