Hedge Your Portfolio With Crypto Derivatives
What Are Crypto Derivatives
Crypto derivatives are financial instruments or contracts that derive their value from an underlying cryptocurrency asset. With crypto derivatives, traders can speculate on the price movements of cryptocurrencies without actually owning the underlying crypto asset.
Crypto derivatives work by having a buyer and a seller enter into a contract to buy or sell the underlying asset at a predetermined price and time. Examples of crypto derivatives include futures, options, and perpetual swaps.
What Is Hedging
Hedging is a risk management strategy that traders use to protect their portfolios from potential losses if the cryptocurrency market does not move in their favour. In crypto, traders typically hedge with derivatives. In this context, traders looking to hedge their crypto portfolio will open both a short position and a long position.
The idea behind hedging and taking two inversely correlated market positions is to offset the losses in one trade by taking an opposite position in the same crypto asset. Hedging works best during periods where there is no clear direction in the market trend.
While hedging can help minimise losses, it also minimises profits. Hedging guarantees that a trader will experience both a loss and a win. For a hedge to be effective, the win must be larger than the loss.
Hedging is a way to manage risk and can be useful for crypto traders who want to safeguard their portfolios during periods of uncertainty.
How Does Hedging Work In Crypto
Think of hedging as buying insurance for your portfolio. Imagine you own some Bitcoin and you are worried that its price might fall in the future. To protect and insure your portfolio, you can hedge by taking a short position.
By taking a short position, you borrow some Bitcoin from a third party (usually a crypto trading platform) and sell it at the current market price. A short position allows a trader to profit when the price of the cryptocurrency falls. If the price of the crypto falls, you can repurchase the crypto at a lower price and profit from the difference.
After you have taken a short position to hedge your portfolio, there are two possible outcomes:
- If the price of Bitcoin goes up, your Bitcoin holdings increase in value but you have to buy back the Bitcoin you borrowed and sold at a higher price. You lose some money on the hedge and short position, but your overall holdings increase.
- If the price of Bitcoin goes down, your Bitcoin holdings lose value, but you can buy back the Bitcoin you borrowed at a lower price. The profit you make from the hedge and short position can minimise the losses on your Bitcoin holdings.
While you might not make as much money as you would if the price of Bitcoin went up without the hedge, you have limited your losses and protect yourself from the risk of Bitcoin’s price going down.
How To Hedge Your Portfolio With Crypto Derivatives
Hedging with crypto derivatives can protect your portfolio from potential losses due to price fluctuations in the cryptocurrency markets. Here’s a step-by-step guide:
1. Select a crypto derivatives trading platform: Download the Flipster app today and experience low trading fees, a wide selection of tokens, and an easy-to-use platform.
2. Understand your risk: Before you start hedging, assess the risks you want to protect against. Determine whether you are hedging against volatility in the overall market or the price movements of specific cryptocurrencies in your portfolio.
3. Calculate your position size: Determine how much of your portfolio you want to hedge and calculate the corresponding position size in the derivative market. The position size should be based on the risk you want to mitigate.
4. Execute your hedge: With perpetual swaps, you can open a short position to profit from market declines. If the market goes down, your short position will gain value, offsetting the losses from your long positions in your portfolio.
5. Monitor and rebalance: Regularly review your portfolio’s risk exposure and your hedging strategy. Adjust your positions as needed based on market movements and your risk tolerance.
6. Cost consideration: Note that using perpetual swaps comes with costs, including trading fees and funding rates. Factor these costs into your hedging strategy.
Risk management is a crucial component in trading. Whether you are safeguarding against market downturns or volatility, understanding how to effectively use crypto derivatives can help to minimize risks and protect your portfolio.
Disclaimer: This material is for information purposes only and does not constitute financial advice. Flipster makes no recommendations or guarantees in respect of any digital asset, product, or service.
Trading digital assets and digital asset derivatives comes with significant risk of loss due to its high price volatility, and is not suitable for all investors.