Whether in traditional finance or in decentralized finance (DeFi), the basic investing concepts operate similarly. Both realms adhere to principles that govern markets and investment practices.
As more complex concepts and algorithms are made to make sense of the market, remember these fundamental concepts that everyone needs to know.
Concept 1: Risk and Return
Investments naturally involve many risks, especially in cryptocurrency. Many perceive the crypto space as the Wild West of finance.
Officially, risk and return references the possible “economic gain or loss from an investment”. At an abstract level, the concept of risk and return is simple: it represents the possibility of loss or gain.
More than just the basic definition of risk and return, we wanted to dive deeper into calculating for risk-return.
While most people assume risk and return are highly correlated (the larger the risk of an investment, the higher the possible reward), there are instances where this is not the case.
Risk-reward ratios are often used to determine whether the risks outweigh the rewards. These ratios and formulas are used in different contexts to inform investors on the profitability of an investment based on previous performance. This can be done by calculating for:
- the alpha ratio,
- The beta ratio,
- and the Sharpe ratio.
When calculating returns, make sure you’re able to identify the differences between realized and expected returns.
Realized returns refer to the actual return on an investment over a specific time frame., while expected returns represent the estimate of profits or losses an investor may receive. While realized returns are a post-fact number and cannot be altered, expected returns are founded on previous data and cannot be guaranteed.
Concept 2: Risk Diversification
Risk represents the potential for loss. Naturally, investors want to mitigate risks while maximizing their return. Risk diversification is one way to do that.
By spreading your investments across different assets and sectors, the notion is that if one area experiences downturns, the others will balance it out.
This works especially well when dealing with unsystematic risk, which is a type of risk that impacts only one business or sector. Examples of unsystematic risk are shifts in leadership, legislative reform, and the like.
As opposed to unsystematic risk, systematic risks are instances that influence the overall economic risk. Examples of these include countries going to war, interest rate hikes, and exchange rates.
Studies and mathematical models have shown that maintaining a well-diversified portfolio of 25-30 assets yields optimal results.
Concept 3: Investment Strategies
Your investment strategy is the set of principles designed to help an investor achieve their investment goals. Strategies are usually based on risk tolerance, goals, and the potential need for future capital.
Investment strategies could range from conservative to highly aggressive, from active to passive. Here are two of the most popular investment strategies on the market (pun intended):
Value Investing
Value Investing is a strategy that involves picking assets that appear to be trading for less than their intrinsic value. Value investors actively look for assets trading under their true value.
Unfortunately, there’s no one way to identify a coin’s true value in cryptocurrency. To do that, you’ll need to account for the coin’s price history, any major investors, and the team behind the coin.
Growth Investing
As opposed to value investing, growth investing is focused on finding opportunities for rapid growth. Typically, investors look for young or small companies whose earnings are expected to grow rapidly, allowing them to invest more in their company and continue their trajectory.
Most angel and venture capitalists use growth investing as their strategy. They look for companies with high growth potential, taking into account solid management, the size of the market, and a great product with a clear competitive edge.
When dealing with new products in emerging markets, also consider the risks that come with them. Regulatory or legal issues could pop up, or new market entrants could overtake the existing market.
Most cryptocurrency projects are speculative investments. They fall under this category due to their high growth potential as we continue to adopt them.
Concept 4: Staking
Staking is more than just a way to earn rewards while holding onto a cryptocurrency.
Staking is a way to contribute to the security and efficiency of a blockchain. They’re generally open to anyone who wants to participate, though do make sure that the crypto you own allows staking in the first place.
Staking works by locking up your assets as participants in network validation. Once you’ve committed to staking crypto, you’ll receive the scheduled returns based on how much you’ve placed - like dividends.
Concept 5: Automated Trading
Automated trading uses algorithms and computer programs to execute trades based on pre-determined rules and mathematical models. The goal is to make the trading process more accessible and reduce the effects of human error and emotional bias.
Trading has always been based on mathematical models and pre-determined rules. As we shift into a more digitalized world, automation allows for more efficient, scalable, and customizable investment strategies.
One of the largest advantages provided by automated trading is the ability to monitor the markets 24/7, something that is impossible for human traders to do.
For example, Peccala’s trading bots utilize proprietary algorithms to analyze market data and predict the probability of an existing trend being amplified. By leveraging complex science, physics, and data science, these bots can execute trades with a high degree of precision and efficiency
Where others “buy the dip” or “sell the rally”, we buy when prices are high and when we expect them to only go higher. This technology enables investors to take advantage of market opportunities at any time, without being limited by human constraints.
Read more about our algorithms here.
