20 Mar 2023 Josphat Kariuki
How To Hedge Against Bitcoin Price Volatility
Bitcoin is known for many aspects. Some are good and some are not as positive. Somewhere in the middle though, sits price fluctuation and it is one of the main factors that can either make or break your BTC trading. As with any asset on the stock market or in crypto, Bitcoin is subject to internal and external market forces, and it is these forces that dictate the BTC price of tomorrow.
How do you safeguard your investment?
While some investors believe in the long-term potential of Bitcoin, others prefer to hedge their investments against the possibility of a market downturn. In this article, we will discuss some of the ways investors can hedge against Bitcoin price fluctuations and therefore, retain the value of their principal investment.
Ways to hedge against BTC volatility
We’ve all heard of hedge funds. The investment vehicles that rule the markets by moving billions of dollars from one asset to another. But what exactly is hedging?
Hedging is a risk management strategy used by market participants to reduce the potential impact of adverse market movements on their portfolios. This type of portfolio management involves taking an offsetting position in a related asset, which is expected to move in the opposite direction of the original position.
Let’s say you are concerned about a potential crypto market downturn. To hedge against this possibility, you could purchase put options, which give you the right to sell your crypto at a predetermined price. If the market does experience a downturn, the put options would increase in value, offsetting the losses on your original stock positions.
Hedging is typically used by investors who have a long-term investment strategy and want to protect their cryptocurrency portfolio from short-term volatility. Such protection though comes at a cost. By leveraging your risk with a hedging strategy, you can potentially miss out on reaping greater benefits from the original investment.
Now, let’s look into ways how you can hedge against BTC price volatility:
- Short Selling: Short selling is a strategy used by crypto traders to profit from a decline in the price of an asset. In the case of Bitcoin, short selling involves borrowing Bitcoin from a broker and selling it on the market. The trader hopes to buy Bitcoin back at a lower price, thus profiting from the difference.
Let’s now look at the short-selling strategy in action. On February 21, BTC price reached this year’s high of $25000. Over the course of the following week, the price started to tumble down, hovering just over $23400 at the time of writing. This means that if you were to borrow and sell on February 21, then re-purchase BTC on February 28, your total profit would amount to $1600 per every Bitcoin sold.
- Options Trading: Options trading is a financial derivative that gives traders the right, but not the obligation, to buy or sell Bitcoin at a predetermined price. It is another great strategy that can help to hedge against BTC price fluctuations. Let’s say you purchase a put option that gives you the right to sell Bitcoin at a predetermined price. If the price of Bitcoin falls below the predetermined price, you can sell the Bitcoin you hold at a higher price and make a profit.
- Futures Trading: Futures trading is a financial derivative that allows investors to trade an asset at a predetermined price and time in the future. In the case of Bitcoin, futures trading allows investors to lock in a price for Bitcoin at a future date. For example, you can purchase a futures contract that lets you buy Bitcoin at a specific price in the future. If the price of Bitcoin rises above the predetermined price, the investor can buy Bitcoin at a lower price and make a profit.
- Dollar-Cost Averaging: Dollar-cost averaging involves investing a fixed amount of money at regular intervals. In the case of Bitcoin, dollar-cost averaging allows traders to invest in Bitcoin over time, regardless of the market conditions. By investing a fixed amount of money at regular intervals, you can average out the cost of your investments and reduce the impact of price fluctuations. This is the most basic way of leveraging risk in crypto trading.
- Diversification: Diversification means that you get exposure to a variety of assets to reduce the risk of loss. Subsequently, you can diversify your investments by investing in other cryptocurrencies, stocks, or bonds. The problem with diversification within crypto markets is that all altcoins follow the price of BTC and often repeat their price behavior one for one.
Market moving forces
In addition to understanding how to hedge against Bitcoin price fluctuations, it's important to understand the factors that affect Bitcoin price. One of the most significant factors is market demand. As more people become interested in Bitcoin, the price tends to rise. Similarly, negative news and sentiment can lead to a decrease in demand and a decline in price. Another factor that affects Bitcoin price is supply, translated in the market turns into how many people are willing to sell at any given moment.
Keep in mind that Bitcoin is a finite asset. Therefore, the rate of production is predetermined by its underlying protocol. As the rate of production decreases over time, the price tends to rise. The regulatory environment can also affect Bitcoin price, with changes in laws and regulations impacting demand and supply. Finally, the broader economic environment can affect Bitcoin price, with events such as recessions, inflation, and geopolitical tensions impacting investor sentiment towards Bitcoin.
Safe trading is the best trading
Bitcoin is subject to price volatility, and the crypto community has a variety of strategies to hedge against these fluctuations. Short selling, options trading, futures trading, dollar-cost averaging, and diversification are all strategies that can be used to mitigate that risk. Established crypto exchanges like Gate.io help you to hedge market positions by offering you most of the above strategies. This means that you don’t have to move your BTC to other platforms in order to trade futures, options or to simply short-sell. It is this speed and flexibility that can safeguard your holdings from losing extensively in value, so choose your trading platform wisely. As for the future of Bitcoin, it keeps growing in adoption and utility, whilst the supply continues to decrease. Now isn’t that the perfect recipe for long-term value growth?
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