2022 has been a turbulent year for riskier assets. Investors have seen the dollar rise to 20 year highs against many major currencies. The Federal Reserve started to raise interest rates and, by July 2022, had added 150 basis points to the Fed Fund borrowing rate. Russia, in February 2022, attacked Ukraine and led an ongoing conflict that is still in full effect. China has locked down its citizens again after another Covid outbreak. The country’s “no Covid policy” has made commerce in the world’s second-largest economy difficult.
While the Bank of Canada, Bank of England, Bank of Australia and several other central banks have increased the borrowing rate, China is in the midst of an easing cycle to help buoy its economy as it comes out of the most recent lockdown. All of these factors have led to turbulence in the cryptocurrency market. The question for investors is how to deal with the volatility and continue to trade without losing your cool.
Do Not Get Emotional
The cryptocurrency markets have been volatile. Crypto trading has been turbulent and difficult to predict. Bitcoin, the largest of the cryptocurrencies, has fallen from above 68K in November 2021 to below 19K in July 2022. In just 8 months, Bitcoin has declined by more than 70%. If you bought at the top of the market in November and held on, you are probably disappointed in the outcome.
When entering the crypto markets, it’s sensible to maintain a cool demeanor and determine each day or week if the position you are planning to take still makes sense. You want to avoid making this a personal situation where you get upset about the performance of your trading deals. This is business, and while you want to make good business decisions, the results may not turn out as you’d planned. Remember, when companies underperform and cannot pay their debt, they sometimes go into bankruptcy. This is purely a business decision. The upshot is that you need to avoid being emotionally involved in this decision.
Create a Risk Management Plan
Like any trading business, you want to make sure that you have a cohesive risk management plan. Your plan should outline how much you are willing to risk on each trade and how much you may be able to gain. Before you place each transaction, you should take stock of your overall risk appetite and only consider deals that fit within those parameters.
While you don’t need each trade to have the same reward versus risk profile, you want the aggregate to equal the goals you have in mind. Try to avoid buying a cryptocurrency and using the “fingers crossed method” to hope your trade works out.
Additionally, you want to avoid letting your losses run. Traders use the term “cut your losses and let your profits run.” In this scenario, you want to find a trend in the crypto market and let your gains continue to perpetuate while you cut your losses and look for a new trade that is more aligned with the outcome you seek.
You also need to know when to fold. You do not want to hold a position and take extended losses that could leave you in a situation where you can incur the risk of ruin.
Know When to Hedge
When you trade cryptocurrency, you want to understand the macro and micro backdrops that can impact your trade. During the 8 months that led to the 70% plus decline in bitcoin, there were plenty of times along the way that traders could have hedged their exposure to mitigate some of the risks. If you plan to take cryptocurrency or commodity risk, you need to know when to manage your risks, even if your trade has not reached your stop level.
Suppose the macro backdrop begins to change, such as when the Fed said they needed to raise rates quickly because they were behind the curve. In that case, you might decide that your position needs to be offset with either another position or instruments that track the movements of your position. For example, if you hold a cash position in Bitcoin, you might consider selling a bitcoin CFD that tracks the trends of bitcoin to hedge against an adverse move in the value of your bitcoin.
For example, If you have a certain amount of bitcoin in an account, and want to hedge or reduce your exposure, you might consider investing in a CFD ‘sell’ deal in order to potentially hedge your exposure to bitcoin. However, these are just basic scenarios and not meant to be taken as any form of trading advice.
Diversify Your Exposure
While most cryptocurrencies trade in tandem, having a diverse group of products to trade in your portfolio can be beneficial. Diversification can mean that you own several types of cryptocurrency or assets, such as commodities, equities, and bonds. Using a diversified basket of assets may help if there are adverse movements in the market. The combination of asset allocation to different assets and diversification within your cryptocurrency holdings is one way to hedge and potentially protect your portfolio from market turbulence.
The Bottom Line The upshot is that you need to have several strategies to ensure you can withstand cryptocurrency market volatility. You want to ensure you do not get emotionally involved in your trading activities and stick to a plan. You also want to ensure you have a strong risk management plan before entering your risk trade. Lastly, you want to have a diversified portfolio to ensure that during adverse market conditions, your portfolio can withstand negative market forces.
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