If you thought you could handle market volatility, Bitcoin’s dizzying ups and downs are something else.
The largest cryptocurrency’s price hit a record high of more than $63,000 per coin in April, when the IPO of crypto exchange Coinbase helped catch the public’s attention. But the rally didn’t last long: Bitcoin’s price quickly dropped back down to around $30,000 in May. Two potential reasons: Electric vehicle company Tesla backtracked on a promise to accept Bitcoin as payment, and the Chinese government cracked down on crypto. Yet another promising tweet from Tesla CEO Elon Musk sent the price crawling back up to around $40,000 in late May.
So when can Bitcoin investors take a breather? If you’re watching daily price moves, probably not anytime soon. But here’s what to know about Bitcoin’s volatility and how to handle it.
Why does Bitcoin’s price drop so fast?
Volatility is nothing new to Wall Street. But when a price can jump more than 70% in one month or lose half its value in just two days, it may make you wonder what’s driving these huge swings.
Of course stocks can also be volatile, but their value is tied to something somewhat concrete: how a company will do in the future. There are ways to check up on how the company is doing, like studying quarterly earnings reports or checking to see how well a company’s products are selling in stores.
Gold is different. Sure, gold has some value from its use in producing jewelry and electronics, but mostly its value is derived from the expectation that you’ll be able to sell it in the future. In this sense, Bitcoin is more like gold, says Hanna Halaburda, an associate professor at NYU Stern School of Business: people buy it because they think the price will increase in the future. But that makes it a speculative asset and more susceptible to volatility since something as small as a skeptical tweet can lead to doubt and maybe spark a selling frenzy.
“You only chase expectations,” Halaburda says. “This is just holding a crystal ball and trying to figure out what the future will bring.”
Bitcoin is also still pretty new, having only been around since 2009. The market is still searching for an equilibrium price; some people think the cryptocurrency is underpriced, some think it’s overpriced. (When Americans were legally allowed to start owning gold in the 1970s, gold’s price was also highly volatile.)
Keep in mind that stock market crashes tend to be preceded by periods of extreme volatility, which is why Wall Street calls the Cboe Volatility Index (VIX) a “fear gauge,” thinking that the ups and downs can tell us whether there is negative sentiment across the market. Volatility doesn’t always lead to a market crash — and it’s not clear if the dynamics are different when it comes to cryptocurrency — but it’s something for investors to keep in mind when determining how much of their portfolio to allocate to Bitcoin.
Invest for the long term
The best way to handle Bitcoin’s massive volatility is probably to ignore it. Easier said than done, but looking at Bitcoin similarly to how you would stocks or bonds can help ensure you won’t blow a bunch of money on a risky investment.
“If you’re committed to crypto in your portfolio, then treat it the same way you would treat a long-term investment, don’t treat it as a fad investment,” says Anjali Jariwala, certified financial planner and founder of FIT Advisors.
Treating it as a fad investment, like the meme stocks that had Wall Street frenzied earlier this year, is how you’ll likely lose money, since you’d be trying to time the market for an asset that is especially hard to time, she adds. But if you’re planning to hang on to your investment for more than a few weeks, months or even years, the dips here and there don’t matter as much.
How to fit Bitcoin into your portfolio
A disciplined approach will be key to surviving the next cryptocurrency crash. One popular move is dollar-cost-averaging (investing a fixed amount of money regularly as opposed to making your whole investment all at once). Say you have $5,000 set aside for risky investments, maybe you add $100 per week to your crypto holding, trickling your money in over the course of a year. One thing to remember: Experts recommend only allocating 2% to 3% — definitely no more than 5% — of your total portfolio to risky investments like cryptocurrency, options trading or individual stocks.
Some professional active traders also use a technique called range trading, which requires picking a range at which they’ll buy and sell a stock over a period of time. The method allows you to limit total exposure by taking gains and “playing with house money” — your previous investing profit — when the market dips, says Jay Hatfield, chief executive of Infrastructure Capital Management. It could be useful for Bitcoin investors, he adds. Following the exact rules of range trading may require more time than you’re willing to spend watching prices if investing isn’t your full-time job — and besides, Money doesn’t tend to recommend active investing for everyday investors — but there are lessons from this technique you can use to minimize risk.
Say you bought $500 worth of Bitcoin. If the price jumps, consider taking out at least your $500, and if the price keeps accelerating, maybe sell half of your holding. That will give you a cushion in case catastrophe strikes, since you’ll hold on to at least your original investment.
“It’s very, very hard to make up for very, very high losses,” Hatfield says. “This kind of risk management where you limit the size and take profits can be effective to avoid huge losses.”
Original source: Money