How to Handle Crypto Volatility
Stock markets are volatile – they go up and down dramatically.
The crypto market is even more volatile than the share market! It’s a characteristic that can put people off.
How can you manage the wild ride and stay on the horse?
To give you an idea of the kind of volatility we’re talking about, let’s look at a few historical examples.
Let’s use a US stock index as a comparison. At the end of 2018 the S&P500 fell around 20% in about three months. Between mid-Feb and mid-March 2020 the index fell over 30%. By early September 2020 it had risen 45% and was at a new all-time high.
This is pretty wild… but crypto
makes that look like child’s play.
From December 2017 to mid-2018 Bitcoin lost nearly three-quarters (75%) of its peak value in six months. From mid-April to mid-July 2021 – three months – Bitcoin halved in value. Then it doubled to reach a new peak in November 2021… and by the end of January 2022 it had almost halved in value again. At one point Ethereum lost 45% in 24 hours.
➤ Note the difference in the scale of and speed of volatility between these two asset classes. This is important to understand and something we’ll get back to below.
Both stocks and crypto are subject to wild runs and substantial, unexpected pullbacks. If you are new to investing, and especially new to crypto investing, this kind of volatility can leave you shaken.
Volatility can be even more disturbing if you’re trying to trade.
In 2021, crypto exchanges had trouble keeping up with the trades and Coinbase experienced some downtime. Binance paused Ethereum withdrawals for a while.
Simply put, this is volatility at its wildest. These types of “red” days never feel good.
I’ve been investing for over 25 years and I still don’t like it… but I know what to do when it happens. And what not to do. And that makes all the difference.
Panic selling is NOT the answer.
Taking a deep breath, reminding yourself of your investing principles and strategy – that is the answer.
Of course, we are assuming here that you haven’t bought crypto at an all-time high (usually a result of panic FOMO buying). That’s the first lesson in handling crypto volatility – make sure you buy at an average historical price, not a high point.
But even if you’re bought at a reasonable price, crypto volatility can put you underwater between breakfast and lunch.
If you don’t have investing principles and a wealth-building strategy… then perhaps you aren’t investing at all, you’re just gambling. If that is the case there is good reason to panic! Not because of the volatility, but because you don’t know what you’re doing or why.
But back to volatility and the crazy selling that you will see from time to time in the crypto market.
Panic selling is THE WRONG MOVE.
It’s important to understand that this type of volatility in the world of Bitcoin and cryptocurrencies is normal.
YEP... you read that correctly. This is the world of crypto. Gigantic roller-coasters.
During the 2017 bull run, Bitcoin experienced multiple drawdowns, some as much as 38%.
In 2016, we saw two pullbacks of more than 30%.
So drops of 30% or more are part of the crypto market. This kind of volatility is not unusual in highly speculative, emerging asset classes.
We don’t get to enjoy the massive
upside without the inevitable drawdowns.
Volatility is the price of admission.
We have to be able to handle volatility if we want to take advantage of the potentially huge gains that are only possible in crypto.
➤ The way we combat this volatility is by having a robust risk management strategy.
In your crypto investing this means limiting your exposure to 5% of your investable net worth (or possibly a bit more if you are still in the building stage of your freedom journey, but never more than 10%).
➤ Added to that, we limit the exposure to each individual trade or holding.
This is a NO-BREAK rule of only putting small amounts into each investment (or “position”). You can keep this a fixed amount and consistent. For crypto positions I suggest no more than $200-$400 per position – or no more than 5% of the money you’ve set aside for speculative assets. When positions start increasing in value you also NEVER chase them up (that is, don’t buy more).
➤ The most important risk strategy of all is that we invest in a well-diversified portfolio with exposure to multiple asset classes (ie, a wide range of investments). It’s the same with crypto. Buy small amounts of twenty different types of crypto, don’t put it all in one coin.
Having investment rules, principles and a strategy to create our sustainable wealth is how we can avoid panicking about these “red” days and sleep well at night.
Perspective is also vitally important. In the crypto world we only have to look back a few months. In early December 2020 Bitcoin was trading just over $19,000… and then it ran up over 200% in three months. The point is that with very volatile investments like cryptocurrencies, you get these huge upside gains because there are also huge pullbacks.
Taking Profits
One of the risk-management tactics I use with crypto is what I call “tranching out.” This is like the opposite of dollar-cost averaging for building an ETF stock portfolio. With dollar-cost averaging you continue investing when the market falls and reduce your average cost. With tranching out, you “average out” your crypto profits.
The idea is to sell a portion of a crypto asset that is running hard each time it goes up a specified amount (eg, 10%). If you sell 10% of your coins (on a reducing basis) each time the crypto price goes up 10% you recoup about half of your initial investment after five “tranche-outs” – but you will still be holding about 60% of the coins you bought in the original position.
The arithmetic of this strategy is really interesting. If you wait for a 25% rise before you start tranching out – and the coin price keeps going up – you end up in a position where, after five tranches, you’ve banked 60% of your initial investment and your position is still up. Best of all, if the coin price retracts all the way back to where you started you still have a 20% gain!
➤ This is a very different approach to the “buy and hold” strategy I advocate for ETFs.
“Tranching out” is a tactic specifically aimed at speculative assets – I use it as a way of protecting against crypto volatility. I don’t recommend for “blue chip” assets.
So if you’re still feeling shaken by the wild rides, now is a good time to reassess your portfolio, check that your exposure to these very volatile assets is within your portfolio design limit, and make sure you’re in a position to handle the volatility.
If you have some money ready to invest, now is the time to get it working for you. “Now” is always the best time… except when speculative assets are at an all-time high, then you need to be patient.
Don’t forget there is still plenty of momentum in the broader crypto market – Bitcoin is just one of the opportunities.
There are already ETFs that focus on the crypto market, which underpins this asset class with institutional support. These ETFs currently focus on the listed companies involved in crypto and blockchain – they do not yet invest directly in the coins themselves. That could change soon – there are rumours that the first U.S. bitcoin ETF will be approved this year. That would be another step toward allowing mainstream investors to easily gain exposure. In the meantime, there are
And institutions continue to enter the space. Most recently, Wells Fargo said it plans to begin helping wealthy clients gain exposure to cryptos.
Plus, sectors like decentralised finance (DeFi) and non-fungible tokens (NFTs) continue to rapidly expand and receive hundreds of millions of dollars in new investments. Those investments are going to bear fruit in the yeast to come.
So, if you’re a bit shaken from time to time, don’t worry. This type of volatility is normal in the cryptocurrency space.
But it is important to remember that it’s crucial to follow a robust risk-management strategy if you invest in crypto.
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As always, thanks for reading and watching and sharing.
Love
Ann
