People invest in crypto currency for different reasons. Many are looking for a get rich quick scheme. The dramatic volatility of the crypto market provides an opportunity to make a lot of money very quickly when the prices go on their parabolic uptrend. But that same volatility can cause people to get poor quickly when the prices plunge downward. Anyone who wants to make money from their cryptocurrency investments needs an understanding of how to manage risk.
The returns we make on any type of investment are a function of risk. The riskier the investment, the larger the potential rewards. But that larger potential for profit is accompanied by a larger potential for loss. Which is why government bonds and bank deposits provide the lowest returns, they’re backed by the government so they are the safest type of investments. Unless the government or the bank fails, you won’t lose any of your money.
More speculative investments are found in the stock market. Company profits are higher returns than government bonds or bank deposits, but there is also higher risk. You can lose all your money if that company goes out of business. Cryptocurrency profits can outperform the stock market by a spectacular amount. $1,000 invested in bitcoin in May 2011 was worth $15.6 million at the end of April 2021. Not even the best performing stocks like Amazon or Google come to that return on investment.
But with those spectacular rewards comes spectacular risk and it takes very strong hands to ride the roller coaster of price volatility bitcoin has seen in that time. Here are some suggestions investors can use to manage the risk and sleep soundly at night.
One strategy is known in the cryptocurrency community as HODL. The term originated from a drunken spelling mistake in a post on the bitcoin forum in 2013, but it soon became a meme. HODL just means to hold, but it’s also developed into the acronym - Hold On for Dear Life.
While bitcoin rises and plunges in dramatic fashion in the short term, holding for a 4 year cycle has always been profitable. Every 4 years Bitcoin undergoes what is called a halving, where the block reward paid to miners is cut in half. This means the inflation rate of bitcoin goes down because the supply of new bitcoin being created is cut in half. And when there is less of something, the price goes up.
Think of Bitcoin as a medium to long term investment and only invest money you won’t need to withdraw in a hurry. Since the price is so volatile, if you have to sell at a particular time, you may have to sell at a big loss. If you can control the timing of when you sell, you can control the profit and manage the risk of needing to sell at a loss during a market crash.
Take profits in a bull run. If you don’t want to take any profit but are motivated to hold longer term, you can cash out your original investment amount and still hold the cryptocurrency. This can reduce any worries you have about losing money because now you are only risking profits. If it all goes pear shaped you will still regret losing the money you could have made, but in the interim it eases your anxiety. Now you can’t lose any of your original investment even if the price drops to zero.
Don’t invest more than you can afford to lose. It’s possible to lose all your money. The technology and asset class is new, conditions can change rapidly and the future is notoriously difficult to predict. The longer bitcoin survives and thrives the less likely it’s price will drop to zero but it’s also not unusual to see 80-90% price drops. That 90% might not technically qualify as losing all your money, but it’s close enough to feel the same as if you did. Make sure you are prepared for that to happen and have considered what you will do if and when it does happen.
Dollar cost average into the market and dollar cost average out in a bull market. Decide how much you can afford to invest and then set that aside each week, or month. You can either buy at the same time each week regardless of the price, or you can wait for a price dip and invest it all at once. Choose a strategy that suits your circumstances. Decide in advance how much you can afford to invest, and then set that aside each week, or month or whatever your schedule is. This averages the per unit price of your investment.
In a bull run use the same principle of dollar cost average when taking profits. Sell small portions of your investment as the price rises. It can help to have the amount and sale price planned beforehand. You can then set limit sell orders in your trading account which means you don’t even have to check the prices. You have created a set and forget investment.
These are a few ideas that may be helpful in navigating the tumultuous cryptocurrency market. You should consider your own financial circumstances and goals and make level headed decisions how you can achieve those goals. Let’s face it, get rich quick sounds easy, but it can turn into lose the shirt off your back just as quickly. And that is no fun at all. Get rich slowly lets you enjoy the journey and gain the satisfaction of planning and achieving your goals, with the added bonus of sleeping easy at night.
