Cryptocurrency Trading 101: Diversify Your Portfolio

cryptocurrency trading diversify portfolio

With the cryptocurrency market booming over the past few months, cryptocurrency trading is rapidly growing in popularity. There has been a flood of new money entering the market, from large companies who have started Bitcoin mining to young couples who decide to start setting aside some extra money for an alternative retirement investing strategy.

Because most cryptocurrencies are “decentralized,” this means that no government agency or other organizations can offer strong regulation on the markets. This is largely considered to be a plus – one of the key benefits of decentralization is that no group can singlehandedly corrupt a cryptocurrency.

On the other hand, this lack of regulation – and the fact that we are still in the early days of digital currency – means that it often feels like we’ve found ourselves in the middle of the Wild Wild West.

Cryptocurrency Trading is Open to (Almost) Everyone

One of the current appeals to cryptocurrency trading is that that it’s widely accessible to everyone.

  • You don’t have to live within any geographic jurisdiction to participate. With the except of a few countries, it’s legal to own and trade cryptocurrencies from anywhere.
  • It doesn’t take a lot of money to get started. Many mutual funds require a minimum investment to get started. This investment can often be a few thousand dollars, making it inaccessible to many. You can start with just a few dollars. Transaction fees for buying or selling a cryptocurrency is typically just a fraction of a percent.
  • Own your investment without relying on others. You can invest in cryptocurrency without depending on another company to handle your money. While you can store your cryptocurrency in an online account, you can also store it on a physical cryptocurrency wallet or even in “cold storage.” No need to set up an appointment with your investment advisor – your investment is owned and controlled by you!

Of course, your freedom to invest in cryptocurrency trading is also your greatest liability. Because the cryptocurrency market is new and minimally regulated, you also have to be wary of cryptocurrency scams. Fraudulent behavior is rampant as criminals seek to take advantage of inexperienced investors.

A scam artist is just one person who may cost you thousands of dollars or more. Who else could harm your success in cryptocurrency trading?

It might just be you.

It’s Time to Educate Yourself

There is no mandatory certification or course that you are required to take before our start investing in Bitcoin or the other digital currencies.

There are a couple things that could happen if you invest in cryptocurrency trading without at least a basic understanding of what you’re doing.

  • Best-case scenario: You profit from investing, but this is primarily due to market factors outside your control and is difficult to sustain over a long period of time.
  • Worst-case scenario: You watch thousands of dollars, or more, wash right down the drain.

Neither of the scenarios – even the profitable one – are circumstances you want to find yourself in. To be a successful cryptocurrency trader, you should make sure you understand:

  1. Basic investment principles
  2. Specific technologies or organizations you are investing in
  3. How your involvement with cryptocurrency trading can help you reach your financial goals

Cryptocurrency Trading 101: Diversify Your Portfolio

Diversification is one of the most basic financial investment principles. What is diversification? Here is a somewhat technical definition:

Diversification is a risk management technique that mixes a wide variety of investments within a portfolio. The rationale behind this technique contends that a portfolio constructed of different kinds of investments will, on average, yield higher returns and pose a lower risk than any individual investment found within the portfolio.

Definition from Investopedia

Diversification is the principle behind the phrase, “Don’t put all of your eggs in one basket.” It helps to spread out the potential risks that come with investment. With a volatile market like cryptocurrency, diversification helps to keep an investment portfolio from seeing such drastic highs and lows.

A Simple Example of Diversification

Let’s take a look at a few different portfolios. We’ll create a few generic coins for this example: Coins A, B, and C. Let’s say that you have $100 to invest.

Go ahead and divide your money into investments before reading below.

The Undiversified Portfolio

When we check back on our portfolio a few weeks later, Coin A is up 30%, Coin B is up 10%, and Coin C has dropped by 40%. Let’s say you decided to put all of your $100 in one coin.

Here are the possible outcomes:

If you invested all $100 in …You now have …
Coin A$130
Coin B$110
Coin C$60

If you decided to invest all of your money in Coin A, you are probably feeling very positive about your investment.

If you chose to invest all of your money in Coin B, you might be mildly pleased but feel like you missed out.

If you invested all of your money in Coin C, you would have been better off leaving your money under your mattress.

The Diversified Portfolio

Let’s say that, instead of putting all of your money into one cryptocurrency, you decided to split your $100 across all three coins.

Coin A is an up-and-coming cryptocurrency yet unproven currency. You decide to invest $20 in this coin.

Coin B has been around for a while. Its price has remained fairly stable over time. You decide to invest $60 in this coin.

Coin C is another popular coin. It has seen huge swings up and down in price, but you want to give yourself a chance of 10x-ing on your investment. You decide to invest $20 in this coin.

Where does this leave you?

If you invested …You now have …
$25 in Coin A$32.50
$60 in Coin B$66
$15 in Coin C$9
Total value$107.50

In this particular case, diversifying your investment turned out to be:

  • Worse than investing in Coin A alone
  • About the same as investing in Coin B alone
  • Better than investing in Coin C alone

As you can see, diversification makes your “extremes” less extreme. Yes, diversification applies to both sides – winning and losing.

While you may not profit on a “winner” as much by spreading your money across coins, you never have to worry about waking up and seeing that your portfolio suddenly dropped to $0 overnight. One of your coins could completely fail, and you’d still have other investments to prop your overall balance up.

Diversify for Long-Term Performance

You might be able to profit from cryptocurrency arbitrage by only buying and selling single coins. However, if serious about profiting in long-term cryptocurrency trading, diversification is the safest strategy. This will work to minimize your risk of loss, both in the short and long run.

Ready to diversify for your cryptocurrency strategy? Consider these two approaches:

  • Basic diversification: Buy cryptocurrencies you don’t currently. Invest in a mix of low-risk (most of your money), medium-risk (some of your money), and high-risk coins (a little of your money).
  • Complex diversification: Consider how the performance of one digital currency might affect another. Invest in coins that are likely to see improved performance if your current investment drops.

Diversification is just one of the many principles you should understand when you want to know how to invest in cryptocurrency. Just like you should diversify your cryptocurrency, you should also “diversify” for your understanding of investment by continuing to learn more each day!

Are you diversifying your cryptocurrency portfolio? How many different digital currencies do you own?

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