Bitcoin, the first digital currency to scale, has managed to generate widespread visibility since the first units were mined in 2009. In that time, Bitcoin has enjoyed astronomical price increases, rising from less than US$0.10 to nearly US$20,000 in 2017.
Given that the digital currency has enjoyed such impressive upside, it is easy to see why investors would want to trade this innovative asset. Bitcoin is highly volatile and managed to lose half its value in less than a week at some points.
As a result, investors can benefit from having a list of go-to strategies they can leverage in order to bolster their chances of success. The following covers some of those strategies.
- Do Your Own Research
Risk is inherent to investment, and it is of the utmost importance that investors conduct thorough due diligence before putting their money into anything. More traditional investments such as stocks and bonds carry a certain level of risk, but Bitcoin is more speculative in nature.
While an investor can look at revenue and earnings when evaluating a stock, or alternatively analyse interest payments when assessing a bond, Bitcoin's fundamental indicators may be less concrete.
In addition to lacking these fundamental indicators, Bitcoin's underlying technology is complex, and learning about it can take significant time and energy. Fortunately, there are a great many resources available that present information on Bitcoin.
One place that investors can start with is the Bitcoin whitepaper, which was distributed by Satoshi Nakamoto, the pseudonymous creator of Bitcoin, in 2008.
- Be Careful
There are several methods that investors can use in order to manage the risk associated with Bitcoin trading. For starters, potential Bitcoin traders should remember the old adage that people should only invest what they can afford to lose.
Further, an aspiring trader could set up a practice account on an exchange and use that account to get familiar with the Bitcoin markets.
Once an investor has gotten this sense of the market, they could set up a regular account and use a small amount of money to trade the cryptocurrency.
- Have A Plan
Investors should make sure they have a plan in place before they start trading. Failing to have a solid plan is a mistake that many beginner traders make. Before making any trades, investors should figure the best time for entering a trade. They should also the determine the best time to get out.
Before making any trades, investors can benefit from determining their profit goal. Further, they should figure out how much they are willing to lose, which can help them with creating appropriate stop losses.
- Stage In
One good way to manage Bitcoin's volatility is to stage in, which involves making incremental investments in the digital currency.
If a trader wanted to start out by putting £100 in to Bitcoin, they could buy £20 worth of the digital currency one week, wait another week, buy another £20 worth, and then continue with this process until meeting their goal.
- Hedge Your Bets
Hedging effectively is another way to manage the risk of Bitcoin's volatility. Investors have many different tools they can use to do this. Traders can use options, for example, to achieve this goal.
Options contracts allow the contract holder to manage the risk associated with a specific asset's rise or fall. An investor could purchase an options contract that would provide a payout if an underlying asset fell in value.
In other words, investors who hold Bitcoin could purchase some options contracts in order to reduce any loss they would experience if the digital currency declines in value.
Bitcoin investors also have the option to trade futures contracts based on the digital currency. Futures contracts obligate two parties to make an exchange at a prespecified date for a predetermined amount.
Diversification is another great strategy that Bitcoin traders can use. While Bitcoin is the world's largest digital currency by market capitalisation, it is certainly not the only digital currency out there. There are many more options that investors can harness if they are interested in doing so.
The basic idea behind diversification is not putting all of one's eggs in to one basket. Ideally, a diversified portfolio allows an investor to avoid losing money due to the fluctuations of its components.
In other words, a diversified portfolio could, for example, consist of five digital currencies. These could be Bitcoin, Ether, Ripple, Litecoin and Monero. If each of these make up 20% of the portfolio, a loss in one component would ideally go along with a corresponding gain in another.
However, conditions are rarely that ideal. Fortunately, investors who are interested in obtaining effective diversification have many resources they can use for their own research.
- Use Wallets
Another good way to strategy to leverage is to harness digital currency wallets.
Many exchanges have been hacked. Bitfinex, a leading digital currency exchange, suffered this fate in August 2016, resulting in the loss of 120,000 units of Bitcoin. This was a high-profile hack, but certainly not the largest.
These two incidents represent a mere sample of the different security breaches that have taken place in the digital currency space. By harnessing wallets, Bitcoin investors can help insulate their digital currency holdings from hacks. These wallets can also help insulate a trader from the risk that the exchange they are using goes out of business.
Risk is inherent to investment, and trading Bitcoin is no different. Fortunately, there are many different strategies that investors can use to manage the various risks associated with Bitcoin trading.
Like any other investment, investors who are considering trading Bitcoin can benefit greatly from conducting thorough due diligence. By performing this key step, they can increase their chances of meeting their investment objectives.
Senior Market Specialist
Russell Shor (MSTA, CFTe, MFTA) is a Senior Market Specialist at FXCM. He joined the firm in October 2017 and has an Honours Degree in Economics from the University of South Africa and holds the coveted Certified Financial Technician and Master of Financial Technical Analysis qualifications from the International Federation…