How to Hedge Risk When Trading Bitcoin Derivatives

Good risk management is an essential component of trading. Particularly so when you’re trading bitcoin, which can be highly volatile, and are using leverage. Given the potential to be forcibly liquidated when the market moves against you, it’s imperative that you take measures to hedge this risk. There are a few ways to achieve this, enabling you to enjoy the upside of the trade while minimizing the downside. Once you’ve learned how to short bitcoin with leverage, your next step should be to dial down the risk without dampening the potential profits. Here’s how.

Use Mutual Insurance

One way to reduce your risk profile when trading BTC is to take out mutual insurance. A number of derivatives exchanges offer this as a product, which is designed to provide short-term protection. Mutual insurance essentially protects you from short-term fluctuations that could otherwise liquidate your position. It’s basically a two-way hedge to be used in situations where you’re expecting volatility and don’t want it to blow up a longer-term position you have open. With mutual insurance, you pay a premium for obtaining cover, and will receive a payout in the event of it being triggered due to market conditions, reimbursing a portion of your losses.

Consider a Two-Way Hedge

If you’re long bitcoin but think it may be due to drop in the short-term, you can open a short position while maintaining your long. For example, you can buy bitcoin or borrow it on certain exchanges that provide margin trading and then use it to short while your long position remains open or vice-versa. If BTC goes up, part of the profits from your leveraged long can be used to cover the sum you’ll have to repay for borrowing BTC for your short.

Lower the Leverage

Crypto derivatives exchanges now routinely offer 100x leverage, and a handful offer even higher still. Cranking up the leverage in a bid to maximize your profits is a surefire way to get liquidated. Leverage of greater than 20x should be used by experienced traders only, and even then it carries significant risk. Start off with leverage of 5x or lower and only increase it once you’re confident you know what you’re doing – and can live with the consequences if you’re wrong.

Set Stops

Setting a stop loss is a smart way to minimize the downside when a trade doesn’t play out the way you’d anticipated. If things go awry, don’t let your liquidation price be hit: that’ll cost you more than manually closing out your position just before it’s auto-liquidated. Since it’s infeasible to monitor the market 24/7, setting stops is the smart thing to do.

Trading bitcoin derivatives is inherently risky if you don’t know what you’re doing. In electing to do so, you’re willing to take on that risk in the pursuit of greater rewards. Learning the available options for hedging that risk is a sign of maturity as a trader, and a smart way to ensure you don’t incur devastating losses when BTC violently wicks up or down. With a hedge in place, you’ll be able to sleep soundly in the knowledge that you’re protected whatever happens.