Starting your journey as a cryptocurrency trader? If your answer is yes, then you need to think smart when it comes to cryptocurrency investments. Once you start with cryptocurrency investments.
The reason is that investors consider diversification as an efficient approach to managing the portfolio. It refers to the different percentages that you allocate to foreign assets. It also requires you to rebalance your portfolio for managing the risk.
Before Start know a little bit About What is Cryptocurrency?
Here we will answer how to invest in cryptocurrencies making use of diversification.
Understanding The Concept Of Diversification
The concept of diversification comes from modern portfolio theory. The theory got developed way back in 1952 Harry Markowitz. The idea assumed that diversifying the assets in a portfolio can maximize profits.
The theory used a term for the measure of risk. It got referred to as Standard deviation. Well, the standard deviation means how much the returns will vary. When the standard deviation is high, then it leads to a wide dispersion of the returns.
Portfolios that get designed as per the modern portfolio theory maximize the returns for a given standard deviation level. Another term which we come across in diversification of portfolio is the efficient frontier. The efficient frontier is a graphic representation of the maximum return achieved for a defined level of risk.
As an investor, decide the percentage you are willing to invest in a specific asset.
Making Your Cryptocurrency Investments
What you must remember is that cryptocurrency is a high-risk asset class. The reason is that the relevant technology has only been around for about ten years. The ecosystem and the industry are still under development.
Well, this is why cryptocurrency investments are volatile. Secondly, the market is unregulated, and it increases the risk factor. Now, investors need to allocate their asset percentages depending upon different aspects.
For example, the investor needs to consider the age of the asset. The net worth and investment time horizon are yet another aspect to be considered. If the investors have a long investment time horizon, there will be more allocation to high-risk assets.
If the investors have a low investment time horizon, they have to allocate more percentage to low-risk assets.
Understanding Low and High-Risk Investments
When you want to invest in cryptocurrency, you need to search for the keyword best cryptocurrency to invest in 2021. The reason is that you need a basic understanding of cryptocurrency investments.
When you are making investments, then an important aspect to consider is the investor’s tolerance for risk. The general psyche of the investors is that they only allocate about 5% to high-risk assets.
You also need to choose a rebalancing period so that you can rebalance your portfolio.
Attempting To Rebalance Your Portfolio
Usually, rebalancing the portfolio is an activity that needs to get done once a month. If the investors indulge in a frequent rebalancing of portfolios, they will need to pay a high fee. Let us assume that in one month, the cryptocurrency appreciates 100%. The stocks depreciate 30%.
As per our assumption, the remaining assets remain the same. The new portfolio allocates 30% to cryptocurrencies and 35% to stocks. 10% gets assigned to cash and 10% to gold. For rebalancing, you will need to sell half of your cryptocurrency holdings.
You will use this to purchase stocks for returning the percentages to their allocations. Cryptocurrencies can get diversified within themselves. A high amount of allocations go to bitcoins in this situation.
The reason is that Bitcoin is a low-risk cryptocurrency. Altcoins get low allocations due to the high-risk factor.
Potential Benefits Of Diversification
The benefit of diversification is that it is more of a straightforward framework. As a result, investors can manage their risk effectively. The theory refrains from allocating all the capital to a one-asset class. By applying this approach, investors can collect a lot of valuable assets while they are cheap.
There are times when an asset continues to appreciate while the other continues to depreciate. In this situation, investors can sell off the appreciating asset to increase the holding in the depreciating asset.
Understanding The Weaknesses Of Diversification
You must bear in mind that it can be difficult to assess an investor’s tolerance of risk. There are times when an investor ends up overestimating the amount of risk.
Now, the best approach to handle this weakness is opting for target allocations, and the benefit of this allocation as an investor is you can trade the cryptocurrency stock market effectively. Investors will need to invest some time and effort to figure out the minimum allocation for each asset.
The best approach to follow is maintaining the target allocation until the cryptocurrency is no longer an emerging tech.
You can make use of the Kelly Criterion to determine the percentage which you need to stake. The Kelly Criterion requires you to put about two variables in an equation. The variables include probability and risk-reward.
The win probability indicates the chance of acquiring a positive return. The percentage for winning can get calculated from similar trades in the past. You can calculate the risk or reward ratio dividing the winning trades losing trades.
Follow this approach when you are looking for a top cryptocurrency to invest in. As an investor, you should keep your emotions aside when investing in cryptocurrency. Try to study market trends. The remarkable thing about the practice is that you will be in the best position to invest sensibly.
It is not a terrible idea to seek assistance from professional traders. The reason is that they have been in the market and know how to trade. By calculating investments, you will be able to fight the volatility of cryptocurrency, so ensure that you follow the smart approach.