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What is hedging in Bitcoin?

31 Mar 2022 By : Rohit Khandelwal
Southeast Asia’s Lar

A hedge is an investment that is made with the intention of reducing the risk of adverse price movements in an asset. Normally, a hedge consists of taking an offsetting or opposite position in a related security.

 Hedging has long been a financial market strategy in the form of a risk management technique for crypto-traders that makes a risk management technique for crypto traders. It allows one to maintain a stable value for your investments (while not making any profits) in turmoil market conditions.

Sincehedging crypto protects would help you procure your investments without any loss while there are some unexpected changes in the market, it also in a sense limits some potential gains one can get while investing in crypto. However, for risk-taking crypto traders, this is a more appropriate option than losing all their assets due to unpredictable price changes and fluctuations in the crypto market.

 

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.

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.

The important governing 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:

1.    Opposite position: The rule is simple. A trader ought to enter a position that is the opposite of its current position. For instance, if you forecast an increase in a cryptocurrency’s price, you should enter a long position.

2.    Liquidity assessment: Traders and investors look closely into a new assets liquidity to determine market integrity, transaction speed, and market fluidity, in order to allow traders to exchange their assets for cash quickly without too much price slippage

3.    Diversification: It is an open secret that diversification is one of the best money management techniques available for traders and investors. You can open multiple positions in Bitcoin(BTC),  Ethereum(ETH), Chainlink (LINK), and many other tokens to create a well-diversified portfolio made up of derivatives.

Types of HedgingMethods

1. 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 crypt currencies protect against long exposure.

1. ShortSelling

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.

2. Futures

Infinite, 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 the liquidity of investors and business owners. Futures contracts are part of a large category of trading instruments known as derivatives, including Contracts for Difference (CFDs), Options,  and Swaps.

3. Perpetual Swaps

Perpetual swaps are derivatives that allow you to buy or sell the value of an underlying asset without setting an expiration date for the position you take (you can choose when to take or exit a position at any time).

Perpetual swaps offer you more buying power than you would have when spot trading. Thus, they place you in a better position to take advantage of price fluctuations. Perpetual swaps operate under a funding rate mechanism in which you pay a fee or rebate to continue holding your position.

4. Options

Options are another type of derivative in crypto. They allow investors the right — but not the obligation — to buy or sell an underlying asset at a specific price, or before a certain date. You can use options as a way to hedge cryptocurrency by limiting downward losses in a declining market.

Put options increase in value when the underlying asset declines below the exercise price of the option, while call options will decrease. This results in a significant level of leveraged hedge protection at a relatively lower cost.

You can also use options for speculation on the direction of a cryptocurrency. Options come as call options or put options. A call option gives you the right to buy a stock, while a put option allows you the right to sell a stock.

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