We’ve all read or heard stories of individuals who became millionaires by mining or buying coins like Bitcoin and Ethereum when they were valued next to nothing. They profited because they had the patience to hold these coins over the years of sudden new highs and lows. But today, let’s talk about the manner in which these investors hit it big — not by simply hodling, but by using a different type of strategy, portfolio rebalancing.
So, what is this portfolio rebalancing anyway?
The term “rebalancing” is the process of realigning or restoring to the previous (default) setting. In portfolio rebalancing, investors have to engage in previously portfolio asset ratio from time to time to maintain a desired asset allocation setting.
The principal intention of using this strategy is to establish a risk management framework that makes sure that the success or failure of one or two assets does not depend on one investment or market.
How does portfolio rebalancing work in cryptocurrencies?
Cryptocurrencies are volatile assets; hence they are high-risk investments, and thus a risk management strategy is a must. Since the price of one cryptocurrency is different from others, a stable coin is used to calculate the portfolio allotment ratio rather than the number of coins holding.
Imagine Bitcoin (BTC), Ethereum (ETH), Tezos (XTZ), and Litecoin (LTC). Allocate 25% of your crypto portfolio to each. After a period of time, the ratio of these distributed assets will change according to their price movement.
For example, your portfolio may now be 26% BTC, 21% LTC, 25% ETH, and 28% of Tezoz.
Now on these new metrics, you can rebalance your portfolio to 25% of each coin again. This way, you will be able to buy the dips of Litecoin and lower your average buying price and book your profits on XTZ and BTC, making sure of a profitable trade in an ever-volatile and risky market.
Rebalancing smooths out the process of profitability of the investment process, effectively forcing the investor to buy low and sell high.
But it is crucial to understand that portfolio rebalancing is just a tool, not the end goal.
How to do portfolio rebalancing
There are three mainstream strategies that are used by many to perform portfolio rebalancing.
Threshold only strategy
In threshold only strategy, traders decide a predetermined rebalancing threshold that acts as a psychological benchmark to rebalance your portfolio. The threshold only approach is well suited for cryptocurrencies, given its volatile nature.
Time only strategy
With the time only approach, the only parameter taken into account is time, no matter how much or how little your portfolio’s resulting asset allocation has drifted from the initial allocation. When using the “time-only” strategy, you rebalance your portfolio at a selected time interval — daily, monthly, quarterly, annually, and so on.
Time and threshold strategy
The time and threshold strategy combine both the above-mentioned strategies. In this strategy, traders rebalance their portfolio at a predetermined time but only if they drift from the minimum cap of a decided threshold.
So if the portfolio is not above the minimum decided threshold at the time of rebalancing, the portfolio won’t be rebalanced. In the same way, if the asset allocation has drifted above the minimum threshold, but the time of relocation has not come, the portfolio won’t be rebalanced.
Advantages of portfolio rebalancing
It helps a trader concentrate on their speciality
Portfolio rebalancing can also be applied to your whole crypto portfolio, rather than just spot. A trader can utilize the spot and other markets like options, futures, and margin to make the most out of cryptocurrency investments. With portfolio rebalancing applied across different crypto markets, traders can concentrate on the markets they specialize in.
Makes sure that traders get the best entries
When you rebalance your portfolio, you buy the dips, meaning you add funds to a coin with PnL in minus, which means you get better entries than your previous entry points.
It helps you revisit your investment strategy
Periodically rebalancing your portfolio gives you a chance to revisit your trading approach and strategy. Traders get a chance to change their investment strategy and ride the waves accordingly. This is one of the reasons why portfolio rebalancing is considered a useful tool for portfolio building and maintenance.
Portfolio rebalancers and holders are in a never-ending debate of which strategy is better, therefore always remember to do your own research. For trading your favorite cryptocurrencies, head over to Giottus.