#CryptoInsights: Diversifying Your Portfolio – Part 1

Diversifying Your Portfolio – Part 1

 

To help get you make informed decisions when investing in cryptocurrency, we’ve developed #CryptoInsights, a series of articles designed to give you all the information you need to optimise the value of your portfolio. If you have any questions about the #CryptoInsights, the Coinage Exchange or anything else Crypto related, feel free to get in touch with us.

Cryptocurrency trading has always been high risk, high reward. In the middle of a bull market when all of your tokens are going up, everyone’s a winner and the sky’s the limit.

But what happens when there is an unexpected crash affecting a few tokens, or even worse, a bear market which sees entire portfolios sink? This is where risk management plays a vital role in determining whether or not you will come out the other end with your portfolio still intact. The central aspect of risk management will be diversifying your portfolio in the correct manner and to the proper degree.

Diversifying your portfolio in its simplest terms means to spread your investments across different assets based on their risk, to minimize your exposure to drops in prices whilst maintaining the ability to make steady gains.

Being Prepared for Multiple Outcomes

Investing is a marathon, not a sprint and the goal is to remain in the game for as long as possible while growing the value of your portfolio .

Having a high-risk, non-diversified portfolio could yield the highest returns, but it also puts you in the greatest danger of having your portfolio wiped clean if you are caught in a crash. If the single token you have your entire portfolio invested in falls prey to a hack or even releases a disappointing update, the effect on your portfolio could be devastating.

This is why finding a solid middle ground is key to balancing risk vs. reward. By correctly allocating different segments of your portfolio to different tokens, you can minimize losses when the market drops, whilst also maximizing your profit gains when your investments begin to rise.

Everyone will have different risk management strategies and in turn, different thoughts on how to best diversify your portfolio. That being said, there are general guidelines which investors can follow to provide a strong foundation for their portfolio diversification.

Identify Each Coin’s Risk Level

One of the simplest ways to break down and diversify a portfolio is through three risk categories – low, medium and high.

No matter how you diversify your portfolio, it is essential to be able to identify a token risk to reward ratio and classify its risk category to determine what percentage of your portfolio to invest. This can also form the basis for further classification and diversification.

Ultimately, it’s up to each investor to find their own unique balance and know what works best for them.

Divide Your Portfolio

Low Risk

If you are planning to be trading crypto assets in the long term, you need a long-term plan. This can be achieved by setting aside a portion of your portfolio dedicated to low-risk trades or holds, as the very high liquidity and market cap can help provide some stability.

For many, this could be solely Bitcoin, but could also include other large-cap coins such as Ethereum, Litecoin or anything else you believe to be a safe large cap or long-term hold. Whilst this category might not bring the highest percentage returns, it is a trader’s main buffer against a volatile market and can keep you afloat even if all other trades fail.

For many low-risk traders, this category will form the most substantial portion of their portfolio.

Medium Risk

Medium risk trades often form the bulk of a traders activity and include top 100 market cap tokens.

These tokens have sufficient levels of liquidity to trade routinely but still have plenty of room to grow, thus providing a balanced risk to reward ratio.

Using medium-risk tokens as the bread and butter of your investing can be an effective way to make consistent gains whilst still minimizing risk.

High Risk

The highest risk investments commonly present the highest reward potential. These investments are the opposite to your low-risk investments – instead of offering a buffer against poor trades, they offer a chance to capitalize on potentially multiple times returns whilst being able to risk only a small percentage of your portfolio.

These tokens are typically low or microcap and new ICOs which have a tremendous potential for growth but also have the highest rate of failure. This category almost always takes up the smallest portion of a traders portfolio to minimize losses as trades are at high risk of complete failure.

Over-Diversifying 

Whilst diversifying your portfolio is encouraged, over-diversifying your portfolio is not. By spreading yourself too thin across many different coins, you will minimize not only risk but also reward.

Over-diversified traders will find that even when coins they have invested in go up in value, their overall portfolio doesn’t seem to grow. This is due to their portfolio reflecting the state of the market and not specific coins – when one of their coins goes up, another one will go down, thus balancing it out.

Setting yourself a rough limit on how many tokens you invest in at one time can help avoid over-diversifying.

Finding your Balance

Once you can determine a token’s risk to reward ratio, it is essential to find your own level of harmony. Each trader will have their own risk tolerance which will draw them to a higher or lower risk portfolio. It is also important to remember there are many different ways to categorize and diversify your portfolio including by type of token. We will be covering this in another article so be sure to look out that in the future.

The Last Word

Diversification is central to any successful investment strategy, particularly one that includes volatile asset classes such as cryptocurrency.

The key lies with learning how to diversify your portfolio, however, as you look to define your ideal risk-reward ratio and strike a balance that reflects your outlook as an investor.

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