Stop-loss is a risk management trading technique used in crypto trading to reduce exposure to falling prices of a financial instrument by setting exit prices should incase the price of the instrument fall to the loss limit the trader can absorb.
As smart as this strategy might be, wrongly applying a stop-loss has led to a decline in capital for many traders due to premature termination of a losing position.
This is why some traders choose to activate a stop loss when they feel they are in an unfavourable trading position which may lead to incurring more losses in the long run.
In this article, I will explain how to trade crypto without using the stop-loss strategy but rather using an alternative known as crypto hedging.
Key Takeaways
• Crypto Hedging is another alternative to the stop-loss that traders use to limit losses during crypto trading.
• There are different types of crypto hedging strategies such as Futures, Options, and Perpetual Swaps you can use if you want to implement the hedging strategy.
• Diversifying your crypto portfolio is a smart move when trading crypto and, even before you apply the hedging strategy.
• Making use of the hedging strategy is not guaranteed as sometimes it may be counter-productive especially if the demerits of using it outweigh the merits.
What is Crypto Hedging?
Source: Atoz Markets
Crypto hedging is a trading strategy that is used to reduce the risks likely to be incurred due to fluctuating prices in cryptocurrencies.
The purpose of hedging is to enable you to limit your losses without the need to make use of a stop-loss strategy.
Now, you might be wondering, what then is the difference between stop-loss and hedging?
Well, while the hedging strategy uses the same methods as a stop loss in limiting losses, it has an edge over the stop-loss strategy because you can still make money on a hedge trade if you select a second trade.
This happens because hedging simply opens another trade to offset an initial trade using second financial instruments.
As such where the stop-loss simply limits your losses (with a reduction of capital), the hedging strategy does that and allows you to make some profit at the same time using the second trade you opened.
With the basics of crypto hedging, there are some rules you would need to abide by should you decide to apply this strategy to your trading activity.
SEE ALSO: How to Scalp Crypto Profitably
Let’s examine them:
Opposite Position
This states that as a trader, you need to enter a trading position that is the opposite of its current position. For example, you should enter a short position if you anticipate a decrease in the price of a given cryptocurrency.
Liquidity Assessment
As a trader, you should examine the liquidity nature of whatever crypto asset you have an interest in. Such assets should be able to have considerable transaction speeds, market integrity, and market fluidity so that you can easily convert them to cash without too much time wastage or price slippages.
Diversification
The old saying of not putting all your eggs in a basket applies here. For crypto, it simply means that you should open trading positions on multiple cryptocurrencies so that you can have a diversified portfolio which in turn will lessen any risk you incur.
Moving on, let us take a look at the types of hedging strategies you can use in the place of a stop loss during trading:
Short Selling
This simply means selling a crypto asset you are currently holding because you believe that the price will fall in the nearest future.
You can make a profit from this process by either buying if/when the price falls or making profits from the difference between what you sold it for and what you paid for it.
This strategy is often used to hedge against long-term positions and the risks that come with it.
Short selling cryptocurrencies involves margin trading in which you can borrow from a broker to trade with the benefits of leverage and traditional short selling where you borrow from a third party to sell and repurchase at a better price.
Cryptocurrency Futures
Just as the name implies, cryptocurrency futures is an agreement to buy or sell a crypto asset in the future at a given price.
In the crypto market, traders usually buy low and sell high but this process may lead to them losing some profits.
In other to prevent this from happening, they make use of crypto futures which leaves their position open for them to maximize profits from their crypto investments.
Futures contracts also exist to hedge your crypto assets against the constant price volatility. It is best to use if you want to hedge your trade in the crypto market against volatility for a particular period.
Perpetual Swaps
The purpose of perpetual swaps is to place you in a solid position where you can exploit price variations to the fullest.
It offers more buying power than spot trading and allows you to buy or sell a crypto asset without setting an expiry date on the position taken by you.
This simply means that it is at your discretion to choose when to leave or take a position at any point in time.
Options
Options are used to speculate on the trajectory patterns of a cryptocurrency in crypto trading. In addition to that, they offer you the right although not mandatory to buy or sell a crypto asset at a particular price or date.
Options serve as a way to hedge crypto by putting a stop to downward losses in a market where the prices of crypto are falling.
Put options increase in value when the crypto asset declines below the exercise price of the option while Call options decrease in value when the crypto asset increases above the exercise price of the option.
It is important to note that while the hedging strategy is an alternative to stop loss during trading, it is not 100% guaranteed so make sure that you weigh the merits and demerits and that you completely study the market before proceeding to make use of it.
SEE ALSO: What is a Crypto Shielded Transaction
Frequently Asked Questions (FAQs)
1. What is crypto hedging and how does it work?
Crypto hedging is a way of protecting your crypto trades from certain risks and works when you open a second trade to cancel out the initial trade you opened while still having the opportunity to make some profit off the second trade.
2. Is hedging crypto 100% guaranteed?
No, hedging crypto is not 100% guaranteed. This is why it is advised that you be sure that the merits outweigh the demerits before applying the hedging strategy.
Final Thoughts
Making use of the hedging strategy is a better way of managing losses than the stop-loss but notwithstanding, you still need to be sure that that is what is needed for your crypto trade at the moment and that the market is right for you to make use of such strategy.
Read More
