Hedging is a method of reducing the potential losses when trading. There are many ways to hedge your investments made for trade and we are here to tell you more. In this article, we shall dive into the concept of hedging, how it is used, what it is used for, and different ways to hedge crypto investments.
Hedging: An Overview
Hedging, as mentioned, is a way to reduce potential losses by opening trades so that a loss or gain in one position is balanced by the changes to the value of the other position. It could be used as a beneficial strategy for traders who want to maintain their original cryptocurrency holding. This creates a neutral exposure.
How to Hedge Cryptocurrency?
Hedging is accomplished through the use of derivatives, a type of financial instrument. Derivatives are contracts between two parties that follow the price of an underlying asset. This allows investors to have a closer look at the price movements of the asset without having to own that asset.
Hedging derivatives yields a return based on the price movements of an asset. All of this could be done without actually owning the asset in question. To explain the process of hedging, when trading crypto options contracts, an investor can either buy “calls” or “puts.” Calls and puts are future rights to purchase and sell an asset at certain rates and prices, respectively. This method is called option trading. To acquire this right, a trader must pay a premium to buy an options contract. Option trading ensures that traders are compensated, especially when the option ends up being unprofitable.
Different Ways to Hedge Crypto Investments
Although there are many popular methods to hedge, here are a few:
1. Short-selling
Short selling is the practice of taking a position to sell an asset. This is done in the belief that it will fall in value and that the user can buy it back for a lower price. This could be explained with an example. Say you have purchased bitcoin and now think that the prices will dip, You have to minimize exposure by opening a short position. By doing this, even if the market falls, you can cover some of the loss to your initial position with gains.
2. Option trading
Options trading could directly be explained with an example. Suppose you are planning to invest in Monad cryptocurrency. You have done your research on the growth and potential of cryptocurrency and know that it will rank higher in the future but you are unsure about the short-term development of the coin. To protect this investment, you can try buying a Monad option. This sets a strike price on a certain future date. If the currency’s price falls below the strike price, you can execute the option and sell the currency at the higher strike price.
3. Hedging with CFDs
CFD trading is one of the best ways to trade. With this method, you will not be required to own any underlying cryptocurrency to open a position. So, you can wager without even having to worry about opening a digital wallet. This also enables you to short-sell without having to borrow Bitcoin.
4. Hedging with futures
When two parties enter into a futures contract, they commit to trading at a predetermined price on a given future date. It is regarded as a valid method for market players to fix a price. For example, you are buying a cryptocurrency for say, $15,000. If the market crashes to $9,000, you will be able to sell it for $15,000 itself, but this goes the other way around too. If the market prices increase to $22,000, you should still sell it for the pre-determined price of $15,000.
Conclusion
By now, you would have understood the basics of hedging. If the user is concerned about the risks in the position they are in, it is safer to reduce the position size or close the position completely while hedging. No matter what, in a trade, risk is an inevitable element. Regardless of the type of returns that an investor seeks, understanding basic hedging tactics will increase awareness of how investors and businesses protect themselves. When it comes to trading, an analyst or trader has to keep learning about new strategies and developing trends to be an efficient trader.