Nobody likes to lose money, but temporary losses are just an inevitable part of investing. This is especially true if you have decided to invest in crypto. However, even during the coldest crypto winters, there are ways to hold out for summer.
Cryptocurrencies are arguably some of the most rewarding and volatile assets available to invest in today. The upshot of that volatility is that these assets can be highly lucrative; however, if you don’t know what you are doing, this presumption can fall flat.
Unsurprisingly, the sharp and prolonged dips often witnessed in the crypto markets result in losses for many investors. This is especially true for those who buy the top and sell the bottom or invest money they otherwise needed and are forced to sell at the worst possible times. Temporary losses due to “price-discovery” and “black swan” events are essentially inescapable. But they can be significantly limited and mitigated by utilizing appropriate risk management measures.
Tools of the trade – Math
“Managing risks” is the golden rule for any investor or trader. The number one objective is “stay alive.” In other words, avoid your portfolio going to zero. The best way to do this is to statistically compare the risk you are taking versus the reward you expect.
The best way to manage risk is to diversify.
Modern Portfolio Theory (MPT) dictates that you shouldn’t put all your eggs in one basket. In other words, investors should not single-mindedly focus on one particular asset but instead spread their investments between a few of them. Not only does diversification reduce risk, but it can even do so without diminishing returns.
It’s even intuitively easy to understand: a portfolio with two assets that have a compounded annual growth rate of 200% and a downside deviation of 20% will be less risky than a portfolio with just one of those two assets. Because even if they look quantitatively similar, intrinsic characteristics make them different.
As a methodology, MPT enables investors to construct a portfolio from several assets.
Since your first objective is to stay alive, you should first and foremost protect yourself from the things that can kill you. For (modern versions of) Modern Portfolio Theory, that’s semivariance. It is a measurement of data that can be utilized to estimate a portfolio’s downside risks.
Instead of trying to optimize returns, you should first and foremost avoid losing money. It’s, therefore, more interesting to use indicators such as semivariance than volatility since all positive volatility is desirable.
Crypto Winter and Negative Volatility
You should only seek to protect yourself from the negative volatility, rather than the kind that’s good for you.
If everything does go south and you manage to make it out alive, how fast can you get back to your portfolio’s previous all-time high? You can use the asset’s Ulcer Index to manage that.
The Ulcer index has the best name in finance because everyone immediately gets it: any time spent below “all-time high” is ulcer-inducing. No one likes ulcers, and everyone wants to go back to previous highs.
You can use the Ulcer Index of various assets to compare how historically likely they are to get you out of a rut compared to other assets.
With this, you have the basic framework of a math-enabled portfolio: Diversified, managed for the risk of losing it all, and its ability to get back from previous lows.
Cooler Heads Prevail
As our explanations above demonstrate, rules-based investing is best, and emotional investing is to be avoided at all costs. But you still have to be able to stick to your rules. Frequently, basic human emotions are the main reason for financial losses. Because often, the possibility of a “jackpot just around the next corner” is simply too enticing for investors to rebalance away from risky assets or to avoid over-investing. Reasons are FOMO (Fear Of Missing Out), the Bandwagon Effect, Gambler’s Fallacy, or Confirmation Bias. All those cognitive biases are likely to make you lose money.
However, dispassionate trading bots, artificial intelligence, and other automated systems are not prone to rash decisions. They can automatically minimize damages by closing positions when the fundamentals no longer make sense, calmly considering numerous factors. Computers don’t get attached to their investments, the community, and cool profile pictures. If you can keep yourself from undermining them, they offer a better chance of success.
Master Your Emotions in Crypto Winter
So while it is always crucial for investors to master their emotions before diving into the market, automated systems can take on much of the complexity and stick to pre-agreed rules, cutting the “human factor” out almost entirely. All humans have to do is resist selling the bottom and buying the tops.
A service such as the OSOM Crypto Autopilot, a crypto portfolio optimizer, is designed to help investors achieve this kind of monotonous growth with a highly diversified portfolio without overcomplicating matters with cognitive bias.
Autopilot’s AI-powered algorithm automatically tracks and finds opportunities among 200+ cryptocurrencies, rebalancing when necessary for optimal diversification. So you can decide what part of your periodic investments you want to allocate to crypto, setup a standing order, and let it manage it all. You then only need to check in on the A.I when you’ve reached your desired time-horizon.
Regardless of experiences, styles, and practices, traders and investors should always strive to utilize every available tool at their disposal. The only way to never lose is not to play at all. But that’s also the only way to never win, and true mastery comes from the ability to prepare for the worst-case scenario, assess the risk, and mitigate it.
About the Author
Mathieu Hardy is Chief Development Officer at OSOM and is based in Brussels, Belgium. Mathieu trained as a cultural anthropologist with a good dose of macro and behavioral economics. Curious about how the digital realm was offering a new playground for social sciences, Mathieu started to work in IT change management and quickly turned to digital business model innovation. At OSOM Mathieu found ample opportunities to leverage technologies in order to re-think business models for a more human-centered finance.
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