It’s critical to use the right tools for the right job.
Without the right tools for a job, even something as simple as cooking becomes a nightmare.
In investing, there are hundreds of tools at your disposal. Different types of investments that differ in their structures and purposes.
Knowing the right ones to use for the right job can be somewhat complicated.
And with the market going through another moment of volatility, a lot of investors are looking to hedge their portfolios.
When investors hedge, they are looking to minimize the risk of their core portfolio. They do this by adding exposure to another asset or position.
What’s alarming is that a lot of credible people are suggesting bitcoin, the first cryptocurrency, as an uncorrelated hedge tool.
They recommend using it as a store of value in volatile times, instead of the traditional approach to owning gold.
I want to debunk the myth of bitcoin acting as a hedge. Today I’ll point out exactly why you should never use it as anything more than a speculative bet on the market.
Let me explain…
Bitcoin: Volatile and Correlated to Market Moves
If you’d like to learn more about bitcoin and why I don’t think it’s a safe tool to hedge your portfolio, watch my video below.
A big case for bitcoin right now is that it will act as a store of value. A place to park cash because it’s uncorrelated from the markets.
That isn’t true.
Bitcoin is a speculative bet. You can’t look at this volatile asset any other way.
Whether it rises 50% from its current level or plunges 50% is anyone’s guess.
What we do know for a fact is that the price of bitcoin is volatile. And it has a strong correlation to major moves in the stock market.
Think back to the stock market correction we went through in the beginning of 2018. Bitcoin prices peaked in December 2017 — that was the top of the bitcoin bubble.
As prices collapsed in the first months of 2018, it dragged many high-flying stocks down with it. And these were stocks that were set to profit from the bitcoin craze.
That spiraled through the markets and handed us a correction that went hand-in-hand with the collapse of bitcoin prices.
The stock market experienced another correction at the end of 2018.
That move also was in lockstep with bitcoin prices. Take a look at the chart below:
S&P 500 Index and Bitcoin Price Drop
The tandem movement between bitcoin prices and the stock market contradicts their supposed noncorrelation.
As this chart shows, there is a clear correlation.
Don’t Park Excess Cash in Bitcoin
Yet many analysts still pitch bitcoin as a hedge against the market. They see it remain uncorrelated for a period of time and assume it’s a great place to park cash when things are volatile.
The problem is that the money in bitcoin is not going to be any safer than any other investment. Bitcoin is an extremely volatile asset with common price swings of 50% or more in just a few days.
This is not the type of asset you want to park cash in or move to when the markets dip 3%.
I don’t have to do the math for you, but a 50% decline is way worse than the 3% dip we saw in stocks early last week.
While bitcoin and other cryptocurrencies are fun to place bets on for the next big move, they are by no means a place to park excess cash or good tools to hedge against the stock market.
Stick with traditional tools.
3 Ways to Protect Your Portfolio
If you are trying to hedge a position, make sure the hedge works properly. It should rise in value while your core position declines.
Your goal with a hedge is to eliminate or reduce the risk of your core assets. In this case, the asset you’d want to hedge is your stock portfolio. That’s why using something like bitcoin won’t help.
We could see a similar situation to the one we saw in 2018 — where prices of both the market and bitcoin fall sharply. In this case, your hedge is losing more value than the asset you wanted to hedge in the first place.
There are two traditional ways to hedge the market:
- To short stocks with a portion of your portfolio.
- To buy put options on the market or individual stocks.
This will give you the results you are looking for. When the market declines, your hedge will rise in value.
I have a strategy that I love to implement in volatile markets. It’s way more conservative than adding exposure to bitcoin or hedging your portfolio. My strategy involves selling put options for income, and holding those positions for three months at a time.
If you want to learn more about the slow and steady opportunity to jump in during volatile markets, head over to my Pure Income service to learn more about it.
Chad Shoop, CMT
Editor, Automatic Profits Alert
P.S. Readers of Pure Income locked in 31 double-digit profits throughout 2018, beating the S&P 500’s average return in the process. And they’ve already earned a string of double-digit gains in the first five months of 2019. Click here to learn more.