Comparing Risks Between Asset Classes
It is only when we have some idea of the risk of our main positions that we can even make an intelligent comparison with the risk of other types of assets such as ethereum where we may then look to add an appropriate amount of balancing to keep our overall risks in line.
If we are bold enough to wish to dabble in what is considered a risky asset such as ethereum, and they don’t come any riskier than ethereum to be sure, what investors tend to do is to set aside a certain small portion of their portfolio which they are comfortable with losing.
Losing all of one’s money on something is almost always a product of bad trading, and something doesn’t have to move against you all that much for this to happen, as we can just make a series of bad trades and go broke and the asset doesn’t even have to move at all on a net basis for this.
When we invest in stocks with a buy and hold approach, we are putting about three quarters of our positions at risk, not by way of black swan events, a stock market crash like we’ve never seen in other words, but just by way of the sort of pullbacks that we see in the market from time to time.
This is comparable to the roughly three quarters of its value that ethereum has given back at the time of this writing from its high, but based upon these two different scenarios, people would consider the risk of drawdown with ethereum to be much higher than with stocks.
Based upon the evidence so far, we couldn’t really say that, as the decline with stock indexes that we saw starting in 2007 was of a similar magnitude. Ethereum very well may have more proportionate downside risk, but it at least hasn’t shown us that this is the case yet.
Asking ourselves how much we could lose on an investment when we’re not using risk controls is a very pertinent question, although we would never want to hold unmanaged positions with something like ethereum, being prepared to ride it down to zero if necessary in other words.
There is a difference here with stocks in that with stocks we can hold a reasonable belief that they may come back, where with ethereum, this is far less known. The probabilility of such a large drawdown over a given period of time is going to be considerably smaller with stocks, but at the same time, we need to prepare ourselves for these big moves because they do happen.
As long as we define our risk with a position, this all can be managed, and this is the real secret to successfully adding something like ethereum to your portfolio, to be prepared to hold it when it is to your advantage to do so and get out when the advantage disappears under darker skies.
Seeking a Profitable Approach with Ethereum as a Secondary Asset
Shorter term holdings reduce the risk per trade, but they also bring in the risk of mismanagement, and since ethereum can really only be held safely on a shorter term than we usually use with stocks, in order to stay within acceptable risk parameters, we need to pay attention to this.
We can call these two different types of risk market risk and trading risk, where market risk is the risk that you will lose money on a given trade, and trading risk is the risk of trading badly and losing money on your trading overall as a result.
The shorter the term of a position, the less market risk there is, because you’re simply not sticking around for the bigger moves against you. Shorter time frames increase trading risk though as this involves more trades over a given period of time with the potential for more mistakes.
Just like one would need to prepare for short term trading, it is very important that we have a good plan in place to avoid a lot of trading mistakes, and ensure that whatever strategy we use with ethereum is one that we may have a reasonable expectation of profit with.
How well we are able to manage our ethereum positions is going to be what drives the appropriateness and amount of ethereum that we will want to use in our portfolios. A poorly managed position, especially with something that has not shown to have any negative correlation with other markets, and one as volatile as ethereum is, will do nothing but impart more risk into our portfolio.
If we are willing to take on the additional risks with ethereum, we must both be prepared to manage these risks properly and also have a plan which has a reasonable expectation of profit. Adding assets to our portfolio should never be done just for the sake of variety, and it doesn’t make any sense to add something which will only serve to reduce our overall expectations just to perhaps take a gamble on it.
What happens when we allocate any amount of our portfolio to alternative investments or approaches, we should not be merely using personal risk tolerance as our only guide, for instance setting aside a certain percentage of our portfolio as so-called mad money which we can take whatever risks we please.
Just because we can lose a lot or all of an investment doesn’t mean that we should, and if an investment may be more challenging to manage that shouldn’t mean that we don’t bother trying. For example, buying a certain amount of ethereum and deciding that it’s too difficult to trade so we just don’t bother trying to manage it.
Managing Ethereum in our Portfolio
While we can certainly make mistakes in managing an investment and we do want to have some sort of sensible plan, and preferably one that can be reasonably relied on in place, not attempting to manage a highly volatile investment such as ethereum is simply not acceptable.
If we are not prepared to do anything to try to help ourselves and just plan on ignoring the ethereum market and just rely on hope, we should not be getting in an investment like this. We may like playing the lottery, but investing should never be seen as pure gambling, even though it does involve gambles of sorts.
The kind of gambling we do with investments is much more like poker than buying a lottery ticket, where our expected outcomes are viewed in terms of probability and we look to get probability as much on our side as we can.
To continue the analogy, good poker players avoid situations where the odds are against us and stay away from hands and bets that do not have positive expectations, or at least avoid the ones that are clearly negative. This is what we must do when we invest as well, and taking positions in something on a lark or for the excitement of it isn’t sound investing at all because it lacks the proper application of our reason.
Therefore, the proper balance when looking to add ethereum to our portfolio will depend a lot on whether we have a sound or at least reasonable plan in place as far as when to enter and exit the position.
We should be looking to first use the quality of our skill level here as far as timing investments in general as a limiting factor, which will range from not investing at all for those who do not want or wish to manage it, to a more significant percentage of one’s overall portfolio among those who are skilled and confident.
This allows the risk of the ethereum component can be better managed and allow for larger positions. When we are considering adding risky components, it always comes down to how well we can manage these additional risks as far as how big a position we can allocate here.
Even with the best risk management skills with ethereum though, there will be limits as how far we can go with it. Presuming that a skilled investor will also manage their main positions well, ethereum is simply riskier than stocks for instance and even with the best management skills we would not want to dedicate too large a portion of our money to something this risky.
Adding assets to one’s portfolio also does not necessarily mean that we will be buying it, going long in other words, and we can and definitely should consider going short an asset like ethereum, especially if we have set aside a portion of our money to be used on it and do not want it sitting idle while we wait for another bull market.
There are no fundamental differences between the long and short side of investments, and shorting isn’t just something that shorter-term traders should be taking advantage of. You can’t just short something and forget about it, but we shouldn’t be ever really doing that on the long side either.
In the right circumstances, including being on the right side of the trend, as well as providing the right guidance, adding an asset like ethereum can certainly provide a nice boost to one’s portfolio.
Editor, MarketReview.com
Andrew is passionate about anything related to finance, and provides readers with his keen insights into how the numbers add up and what they mean.
Contact Andrew: andrew@marketreview.com
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