Simple Crypto Hedging Examples

Simple Crypto Hedging Examples

Welcome to the world of cryptocurrency hedging! If you hold cryptocurrencies in your Spot market portfolio—meaning you own the actual coins—you might worry about sudden price drops. Hedging is a strategy used to reduce or offset potential losses in your main holdings by taking an opposing position elsewhere. For beginners, the easiest way to hedge crypto is by using Futures contracts.

This article will walk you through simple, practical examples of how to use futures contracts to protect your spot holdings without needing complex financial instruments. If you are new to this, it is helpful to read A Beginner’s Introduction to Crypto Derivatives first.

What is Hedging in Crypto?

Imagine you own 1 Bitcoin (BTC) bought at $50,000. You believe in BTC long-term, but you see bad news coming out next week that might cause a temporary drop. You don't want to sell your actual BTC because you plan to hold it for years. Hedging allows you to take a temporary "short" position (betting the price will go down) using futures contracts to cover the potential loss on your spot holding.

The Goal: Not to make massive profits from the hedge itself, but to keep the *value* of your total portfolio stable during the risky period.

Partial Hedging: The Most Common Beginner Strategy

Complete hedging means perfectly offsetting 100% of your spot position. For beginners, this is often too complicated because futures contracts are traded in specific sizes (lots) and often involve leverage.

Partial hedging is much simpler: you only protect a portion of your spot holdings.

Example Scenario:

1. **Spot Holding:** You own 1.0 BTC. 2. **Risk Assessment:** You are moderately concerned about a short-term dip but still bullish overall. You decide to hedge 50% of your position. 3. **Futures Action:** You open a short position in the BTC futures market equivalent to 0.5 BTC.

If the price of BTC drops by 10% (from $50,000 to $45,000):

• **Spot Loss:** Your 1.0 BTC spot holding loses $5,000 in value (10% of $50,000).
• **Futures Gain:** Your 0.5 BTC short futures position gains approximately $2,500 (10% of the notional value of $25,000).
• **Net Effect:** Your total loss is reduced from $5,000 to $2,500. You successfully protected half your exposure.

This strategy is often favored because if the market unexpectedly rallies instead of dropping, you still benefit from the price increase on the 0.5 BTC you left unhedged. For more on using futures for protection, see Hedging with Perpetual Futures: A Smart Strategy for Crypto Portfolio Protection.

Timing Your Hedge Entry and Exit with Indicators

A key challenge in hedging is knowing *when* to open the hedge (the short futures position) and, more importantly, *when to close it* so you don't lose money when the market turns back up. We use technical indicators to help time these moves.

Three very common indicators used for spotting potential reversals or strong trends are the RSI, MACD, and Bollinger Bands.

1. Using the RSI (Relative Strength Index)

The RSI measures the speed and change of price movements. It ranges from 0 to 100.

• **RSI Overbought (Above 70):** Suggests the asset might be due for a pullback or correction. This can be a good time to *enter* a short hedge on your spot holdings.
• **RSI Oversold (Below 30):** Suggests the asset might be due for a bounce. This is a good signal to *exit* your short hedge position and let your spot holdings recover their value.

2. Using the MACD (Moving Average Convergence Divergence)

The MACD helps identify momentum and trend changes.

• **Bearish Crossover:** When the MACD line crosses *below* the Signal line, it indicates downward momentum is increasing. This is a signal to *enter* your short hedge.
• **Bullish Crossover:** When the MACD line crosses *above* the Signal line, it indicates upward momentum is returning. This is a signal to *exit* your short hedge.

3. Using Bollinger Bands

Bollinger Bands measure volatility. They consist of a middle moving average and two outer bands representing standard deviations above and below the average.

• **Entering the Hedge:** When the price touches or moves outside the *Upper Band*, it suggests the price is extended to the upside and might reverse downward soon. This is a good time to consider *entering* a short hedge.
• **Exiting the Hedge:** When the price moves sharply down and touches or breaks the *Lower Band*, the asset is considered oversold. This often signals an end to the immediate downward move, making it a good time to *exit* the short hedge.

Combining Indicators for Stronger Signals

Relying on just one indicator can lead to false signals. Professional traders often look for confirmation across multiple tools. For example, you might only open your short hedge if the price hits the Upper Bollinger Band *AND* the RSI is above 75.

Example Timing Table (Using a 4-Hour Chart for BTC)

This table illustrates a hypothetical situation where you decide to hedge 0.5 BTC when you see strong short-term bearish signals.

Indicator Signal	Action Taken	Rationale
Price touches Upper Bollinger Band	Consider Hedge Entry	Price extended high, potential reversal coming.
RSI reads 78	Confirm Hedge Entry	Strong overbought condition confirmed.
MACD shows Bearish Crossover	Execute 0.5 BTC Short Hedge	Momentum shifting down.
Price touches Lower Bollinger Band	Consider Hedge Exit	Price extended low, potential bounce coming.
RSI reads 25	Confirm Hedge Exit	Strong oversold condition confirmed.
MACD shows Bullish Crossover	Execute Exit of 0.5 BTC Short Hedge	Momentum shifting up.

Understanding the Relationship Between Spot and Futures Pricing

When you use futures to hedge, you must be aware of the basis—the difference between the spot price and the futures price.

• **Contango:** When the futures price is higher than the spot price (common for longer-dated contracts).
• **Backwardation:** When the futures price is lower than the spot price (often seen in strong uptrends or when perpetual futures funding rates are very high).

If you are hedging a spot position using a perpetual futures contract (which is common in crypto), the funding rate mechanism will influence your overall cost. If you are short (hedging a long spot position), you will *receive* funding payments if the funding rate is positive, which helps offset the cost of holding the hedge. If the funding rate is negative, you will *pay* funding, increasing the cost of your hedge. Understanding Crypto Market Trends with Volume Profile: Analyzing ETH/USDT Futures for Key Support and Resistance Levels can provide deeper context on market structure.

Crucial Risk Notes for Hedging

Hedging is a risk management tool, not a profit-making tool. If executed poorly, it can increase your costs or lock in losses.

1. **Cost of Carry:** Every time you open and close a futures trade, you incur trading fees. Hedging frequently can erode profits due to transaction costs. 2. **Over-Hedging:** Hedging too much (e.g., hedging 150% of your spot position) means you will lose money if the market unexpectedly rallies, as your short futures position will lose more than your spot position gains. 3. **Forgetting to Unhedge:** This is the most common beginner mistake. If the market dips, you hedge, the dip passes, and the market rallies significantly, but you forget to close your short futures position. You then miss out on the rally because your short position is losing money exactly when your spot position is gaining. Always set alerts or reminders for when your indicators suggest the hedging period is over.

Psychology Pitfalls in Hedging

Managing your emotions is vital when hedging because you are intentionally limiting potential gains or locking in temporary losses.

• **Fear of Missing Out (FOMO) on the Hedge:** You might see a massive drop coming and hedge 100% of your position. When the price only drops 5% and then rockets up, you feel like you missed out on huge gains. This can lead you to remove the hedge too early, exposing you to the next dip.
• **Anger at "Wasted" Trades:** If the market never drops after you open your hedge, you will see a loss on your futures position (offset by no gain on your spot position). It is essential to remember that paying a small amount to protect against a catastrophic loss is a successful trade, even if the loss never materialized. You paid for insurance.
• **Greed When Exiting:** When the market finally drops and your hedge is profitable, greed can stop you from exiting. You might hold the profitable short hedge hoping for a deeper crash, only for the market to bounce back, erasing your hedge profits. Stick strictly to your exit criteria based on your indicators.

Hedging is a defensive strategy. It protects your wealth during uncertainty, allowing you to hold your core crypto assets with greater peace of mind. Start small, hedge only a fraction of your portfolio, and only use indicators you fully understand.

See also (on this site)

• MACD Crossover Exit Signals
• Bollinger Bands for Volatility
• Spot Versus Futures Leverage
• Common Trading Psychology Traps

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