Thinking about trading cryptocurrencies like Bitcoin? Let’s talk risk management.
Cryptocurrencies, like Bitcoin, have seen increasing interest among retail investors in recent years. The investments in bitcoin by institutional investors and electric car maker Tesla only served to push that interest over the top.
But let’s be clear. Cryptocurrencies are a speculative investment asset.
Cryptocurrency prices can and do experience extreme market volatility. Digital currencies like the popular Bitcoin, can hit extreme lows and highs within a 24-hour period. On May 19 this year, Bitcoin fell to US$30,000, the lowest since January 2021, before recovering at US$38,000. Just 10 days before, the cryptocurrency had been trading at US$58,000 levels.
Bitcoin and cryptocurrency prices also do not appear to trade with any fixed pattern, beyond the occasional blips from bans by regulatory bodies and tweets by Tesla’s CEO Elon Musk.
Why is Bitcoin so volatile?
There are a couple of reasons for this volatility.
For one, Bitcoin’s real use case scenario remains tenuous. Beyond the use of the digital currency by some Bitcoin afficionados, and a couple of cafes in Singapore that are said to accept the digital currency as payment, there are few other areas where regular consumers can and will use Bitcoin in real life.
Another reason lies in the lack of regulatory oversight which, incidentally, is the very reason Bitcoin was created in the first place. Bitcoin is mined, distributed, traded, and stored with a decentralized ledger system, also known as blockchain. By its very nature, since it isn’t issued by any central bank, it is proving to be more difficult to be regulated by them. At the same time, bitcoin proponents believe regulation would only serve to stifle innovation and curtail trading volumes.
On the other hand, the lack of regulatory oversight impacts the level of trust consumers and traders have in the digital currency, particularly as bitcoin has been known to be involved in scams, and illegal activities.
Ways to invest in Bitcoin safely
With this in mind, here are some ways investors can think about investing in Bitcoin while actively mitigating the risks.
1. Do your research.
Before putting your money into any new investment, you should first know what you are investing in. In this case, you can start by reading the original whitepaper on bitcoin by Satoshi Nakamoto, and learn more about the factors that affect its supply and demand.
2. Invest only what you are prepared to lose
Suffice to say, any investment in Bitcoin should not involve funds that you cannot afford to lose. Being a high-risk investment asset, the rewards can be huge, or leave you with nothing.
3. Start small
Investing small amounts at the start can help you to familiarise yourself with the market, and hone your trading techniques, before putting in larger trades. Even then, you should never put all of your money in a single trade.
4. Know how you want to invest (Bitcoin vs Bitcoin derivatives)
There are a few ways to invest in bitcoin. You can participate in the bitcoin market by purchasing the actual currency. This would involve buying bitcoin through a reputable exchange and storing it in a hot or cold wallet.
You can also invest in the price fluctuations of bitcoin through derivative products like funds, ETFs, and Bitcoin CFDs.
There are some key differences between trading bitcoin and bitcoin derivatives. A direct investment in bitcoin provides the most direct exposure, both to its risks and rewards. On the other hand, trading bitcoin CFDs can be an effective complement to Bitcoin trading as it allows investors to hedge their long position.
5. Have a plan in place
In a market as volatile as Bitcoin, the last thing you want to do is to sell off your position impulsively because prices have fallen, potentially making a big mistake. So you need to craft out your trading plan.
If you plan to do day trading, or trading the volatility of the market without holding overnight positions, then you should practice having profit targets and stop losses for every trade you place.
Alternatively, you might subscribe to the “buy and hodl” investing strategy. For the uninitiated, “hodl” is a deliberate misspelling of the word “hold” and is used by bitcoin investors to mean “hold on for dear life” or invest for the long term.
As a “hodler”, you should be prepared for your investment funds to be locked into the digital currency for a long period of time, and they should not be required for any future expenses, investments or emergencies.
With these simple risk management principles, you will be better equipped to handle any of the volatility that Bitcoin trading could – and probably will – throw your way. If you would like more information for risk management in trading Bitcoin, you can contact Phillip Futures.