Rebalancing
Rebalancing, in the context of cryptocurrency, is a financial strategy employed by cryptocurrency investors and traders. The basic objective of rebalancing is to maintain a desired balance of different cryptocurrencies in one's portfolio, which can alleviate some of the risks inherent in the constantly shifting cryptocurrency markets. This balance is maintained by periodically buying or selling cryptocurrencies to match the initially defined portfolio composition.
What is Rebalancing?
Why is Rebalancing Necessary?
- Maintaining Asset Allocation: Cryptocurrencies have highly volatile price movements. Over time, the allocation of a certain cryptocurrency in your portfolio can drastically change. Rebalancing helps maintain the original or desired asset allocation.
- Risk Management: The risk profile of your portfolio can become distorted due to the high price swings in cryptocurrencies. Rebalancing helps control risk by ensuring investments remain diversified across a variety of cryptocurrencies.
- Profit Booking: Rebalancing can also serve as a systematic strategy for booking profits. When the proportion of a certain coin increases significantly in value and hence, the portfolio, selling a part of it would realize some of the profits.
How is Rebalancing Done?
Rebalancing involves two main steps. First, you must set your desired cryptocurrency portfolio allocation. This might be a 50/50 split between Bitcoin and Ethereum, for example, or a more complex allocation involving numerous coins. This step is highly individual and should be based on personal investment goals, risk tolerance, and beliefs about the future performance of different cryptocurrencies.
Next, you'd periodically adjust your portfolio to match this desired allocation. This could mean buying more of a cryptocurrency whose value (and thus proportion of your portfolio) has fallen, or selling some of a cryptocurrency that has risen in value.
The frequency of rebalancing can also vary based on individual strategy and market conditions. Some investors might rebalance their portfolio weekly, others might do it monthly or quarterly.
Keep in mind that while rebalancing is a proven financial strategy, it's not a guarantee of profits especially in the highly volatile cryptocurrency markets. Rebalancing can help manage risk, but it cannot eliminate it.