Market-neutral strategies could be slightly more complex than buying and selling, so traders must consider the advantages and disadvantages.
A market-neutral trading strategy aims to make returns that are uncorrelated to the movements of the cryptocurrency market. It involves keeping an unbiased stance by taking both long and short positions.
Market-neutral strategies have proven to be a helpful tool for reducing overall trading risk while preserving returns by benefiting from the relative price change between two digital assets.
This article will explore how market-neutral strategies work and what to consider when taking this approach.
What Are Market-Neutral Strategies?
Traders can profit from both upswings and downswings by implementing market-neutral strategies. Such an unbiased stance is essential to exploit any momentum in the cryptocurrency markets.
The key is to make concentrated bets based on price discrepancies rather than the directional performance of a single digital asset.
While most cryptocurrencies keep a high correlation coefficient, the volatile nature of the market usually provides an opportunity for traders to implement market-neutral strategies. This is also common in traditional markets, known as hedging – taking an offsetting or opposite position in different assets.
Benefits of Market-Neutral Strategies
One of the main benefits for traders who implement market-neutral strategies is the ability to mitigate market risks to make the most out of their trading capital.
In uptrends and downtrends, digital assets move in different directions and generate price discrepancies between spot and futures markets. The goal is to identify those digital assets that aren’t correlated or price differences between different markets to implement market-neutral strategies.
Given the high volatility that cryptocurrencies usually go through, market-neutral strategies enable traders to exploit any sort of bullish or bearish momentum. Such a plan of action is vital to achieving low positive correlations with the market as the losses from one position can be offset by the profits from the other.
Drawbacks of Market-Neutral Strategies
While market-neutral strategies can provide benefits, like reducing risks during periods of extreme volatility, there are a few disadvantages that traders should be aware of.
Market-neutral strategies are more complex than simply buying and selling cryptocurrencies. Traders must identify which assets are the least correlated to enter the correct positions. More importantly, timing is a significant factor when implementing the statistical arbitrage approach because executing two-legged spreads can be challenging as price movements are fast-changing.
One must also have a clear understanding of the proper size of each position and where stop-loss orders can be placed. This depends on the trading capital available on the account and the trader’s risk tolerance. It is imperative to determine the dollar amount that will be traded and the dollar amount at risk before entering any trade.
Another factor to consider when implementing market-neutral strategies is trade execution or slippage – the difference between the expected price of a trade and the price at which the trade is executed.
Basis Trading
Basis trading involves taking offsetting or opposing positions of the same cryptocurrency in the spot and derivatives markets to profit from price differences. Such price difference is called the basis.
Although no one knows what the price of an asset will be on any given date in the future, one can identify the basis before it moves to zero upon the expiration of a derivatives contract. For this reason, basis trading can be profitable when executed carefully and implementing a robust risk management strategy.
For instance, a trader purchased BTCUSDT for $45,510.34 on Binance on Mar. 31, 2022, and short-sold the equivalent amount of the BTCUSD Quarterly 0624 futures contracts at $46,021.60 on Binance Futures. The trader was able to lock in a price differential upon expiration of the derivative contract with a profitable $511.26 basis per contract.
With basis trading, the key is to identify the price differences in the spot and derivatives markets of the same cryptocurrency to earn a profit. Traders aim to capture the premium while avoiding exposure to the underlying asset's price movements.
Statistical Arbitrage
Statistical arbitrage involves creating a profitable situation stemming from pricing inefficiencies among crypto markets.
Pairs trading is a common type of statistical arbitrage involving cryptocurrency pairs that usually move mutually, but when the two assets behave abnormally, the pair would be traded. The open positions would then be closed when the assets' behavior reverts to their normal mode.
Two statistical methods used to identify price relationships are correlation and cointegration. Correlation refers to the degree to which two assets move to each other. Meanwhile, cointegration helps identify cryptocurrencies that may behave independently in the short term but are likely to revert to equilibrium in the long term.
For instance, LUNA saw its price increase by more than 84% between Feb. 16, 2022, and Mar. 10, 2022, while FTM incurred over 40% losses during the same period. A market-neutral trader could’ve opened a long LUNA position to benefit from the rising price action and a short FTM position to profit from the steep decline this asset experienced.
Summary
By taking long and short positions simultaneously, returns could be made no matter what the general market is doing. For this reason, market-neutral strategies may present more advantages and opportunities for traders when the direction of the trend remains uncertain.
Market-neutral trading strategies involve minimal risks, but traders should remember that this only applies when executed precisely and with a robust risk management strategy. This type of trading will involve active management as traders must keep track of market developments and watch multiple assets.
Traders can test their market-neutral strategies on Binance Futures’ mock trading environment with zero risks. So sign up today and put your trading skills to the test!
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Disclaimer: Crypto assets are volatile products with a high risk of losing money quickly. Prices can fluctuate significantly on any given day. Due to these price fluctuations, your holdings may significantly increase or decrease in value at any given moment, resulting in a loss of all the capital you have invested in a transaction.
Therefore, you should not trade or invest money you cannot afford to lose. It is crucial that you fully understand the risks involved before deciding to trade with us in light of your financial resources, level of experience, and risk appetite. If required, you should seek advice from an independent financial advisor. The actual returns and losses experienced by you will vary depending on many factors, including, but not limited to, market behavior, market movement, and your trade size. Past performance is not a guide to future performance. The value of your investments may go up or down. Learn more here .
