Last week, we mentioned “Never put all your eggs in one basket” as a golden rule to protect you from market volatility in the previous article: Top 5 crypto investment rules for beginners, Today Tokenize Xchange will dive deeper into diversification strategy to understand why it matters to your investment and how to diversify your crypto portfolio.
What is portfolio diversification?
Portfolio diversification means investing in different assets with variable scopes of risks to limit the price swings of their investments. Since it is impossible for all industries to go up or down at the same time, a well-diversified portfolio will save investors by spreading the risks among different investments.
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According to Modern portfolio theory (MPT) by Harry Markowitz, investors can create an investment portfolio to maximize their expected return based on the level of market risks. Accordingly, the expected return could be calculated as the weighted sum of the individual assets’ returns.
The best portfolio should be the one that is optimal in terms of both types and quantity. In other words, the best portfolio is the one with the highest expectation of return.
Why does asset diversification matter to your investment?
We have mentioned risk reduction as the reason for portfolio diversification, however, are you curious how it works?
Let’s say you have a crypto investment portfolio that only has hotel and hospitality stocks. The share price would drop following crises or catastrophe that has negative impacts on tourism such as Covid-19, leading to a significant drop in your portfolio value. What if you diversify your portfolio with hospital and healthcare stocks? Your healthcare share price would rise like a rocket during the pandemic and make an offset to your hotel stocks.
The similar situation occurs with crypto by diversifying your crypto portfolio, you are making sure you don’t put all your eggs in one basket. Different digital assets don’t react the same way to adverse events.
A combination of cryptocurrencies like Bitcoins and Altcoins will reduce your investment portfolio’s sensitivity to market fluctuation because of their moving in opposite directions. Hence, if you diversify, the downward trend in an asset will be balanced by positive movement in others.
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How to diversify your crypto portfolio?
Newbie traders may tend to put their money into Bitcoin for their first investment, but Bitcoin is absolutely not the only existing coin in the market. Ethereum is the biggest altcoin that is quickly catching up to Bitcoin. But don’t forget coins like Litecoin (LTC), Polkadot (DOT), Cardano (ADA), and Polygon (MATIC). Over the last months, ETH shows an upward trend, followed by LTC, DOT, ADA, and MATIC.
Remember that each cryptocurrency is distinguished by its features. For example, while Bitcoin is a transactional digital token, Ethereum is more like yield-farming crypto, and EOS tokens are commonly used for smart contracts. Hence, it is necessary to understand your cryptocurrencies’ features to protect you from market volatility in case one crypto dips in value.
Some examples of crypto portfolio diversification. Source: cointelegraph.com
So, how to diversify your crypto investment portfolio? We recommend some investment strategies to help you with cryptocurrency diversification.
The investment strategy here is to look at different projects from different locations. There is a recent shifting trend towards investing in Asian cryptocurrency projects. If you are holding some European cryptos, it would be a chance for you to diversify your portfolio with some Asian or American projects to avoid some external issues regarding regulations in each country.
Types of cryptocurrency
The approach here is to choose different types of digital coins and invest them. Some suggested options are Bitcoin, stable coins, security tokens, and utility tokens.
This is one of the oldest portfolio diversification strategies though not often highlighted. Timing the market is challenging, let alone a strongly fluctuating market like cryptocurrency. By comprehensive execution, investors can long and short some of their portfolio items in swing trading while holding others for a long-term investment. If you are in the long run, you may need this strategy.
The idea of this strategy is to make sure you own an ultimate crypto portfolio with different industries, for example, supply chain, medicine, or finance. In this way, if one segment suffers a huge loss, the rest of your portfolio can minimize the impact on your returns.
No matter which crypto investment strategy you are following, remember to keep a logical mindset, do your own research to find out good assets to diversify your crypto portfolio, and stay away from FOMO then you will be fine.
So, what is your strategy?