As cryptocurrencies continue to gain traction, traders search for ways of protecting their holdings from risks – that’s where hedging comes in. Find out more about it below!
What Is Hedging?
Hedging is a trading strategy used to prevent potential financial losses by taking an offsetting position in an asset that decreases the price risk of an existing position.
What You Need To Know About Hedging
The hedging definition is best explained through an example. For instance, there could be a trader who is mainly investing in bitcoins but wants to protect their assets against a potential short-term market downturn. In this case, they can opt for derivative trading instruments that will yield a profit should the value of bitcoin fall.
The most common derivatives used in hedging crypto trading positions are:
- Put options. This solution enables investors to go long and gain profit when the price of an underlying asset increases or to go short and profit when it decreases.
- Futures contracts. These are agreements that give the investor the right to buy or sell an asset at a certain price on a specific contract settlement date.
- Perpetual swap contracts. Also known as “perps”, these contracts are very similar to futures. However, the key distinction is that they can be rolled over continuously. This provides investors with a means of hedging that does not have a predetermined settlement date.
These derivatives used in hedging are essentially contracts between two parties that monitor the price of an underlying asset. This means that derivatives allow investors to track the price movements of a crypto asset without having to own it.
All in all, hedging is a great option for crypto enthusiasts that want to take away a fair share of guesswork from their trading decisions and help to mitigate the risks in times of market turbulence.
