What does it mean to 'hedge' your portfolio?
In finance this is the practice of taking an opposite position in an asset you have invested into in order to protect you from the downside. Think of it as insurance.
Just like insurance you often have to pay a premium for the benefit of downside protection.
1. An example
Let's say you invest $1,000 into BTC. BTC goes up to $10,000. You are happy.But you want to make sure it doesn't go down so you "hedge" by going short on some ETH (which goes down when BTC goes up). So now you have $1,000 invested in BTC and $500 short on ETH.If BTC goes down to $5,000 then your ETH will go up to about $2,500 (($5,000 - $2,500) / ($2,500 + 0)), plus the extra money back from the short position so you get back almost what you invested in BTC.So if BTC is at 10k and ETH is at 1k and they both move up or down by 50%, then:BTC would be 5k and ETH would be 2k and you would have:BTC = 9kETH = 3.5kIn other words, despite the fact that both coins moved up by 50%, your portfolio still has a 33% gain because of the hedge.On the other hand...
2. What if they move in opposite directions?
If they move in opposite directions then it gets harder to predict which way your portfolio will move.Say ETH goes down to 600 while BTC is at 10K. Your portfolio will go down even though only one asset went down (and the other went up). If they each go up by 50% then your portfolio will only go up 30%.This is why people often talk about diversification as a strategy for investing rather than focusing on just one asset at a time.
3. How do I hedge my own portfolios?
I don't do this but I know people who do it all the time.For instance, when Ethereum was going up against Bitcoin I would say "this looks like a bubble".So I sold some Bitcoin and bought more Ethereum with the proceeds (the sell of Bitcoin created cash which I used to buy more Ether).When Ether went down against Bitcoin I took profits or did hedging (depending on how much cash was left over after buying Ether).The reason for this is that there are many instances where an asset does not move in lockstep with another but moves enough that someone can benefit from making these bets within their portfolio as opposed to simply picking one over the other based upon gut feeling or speculation about which one is better technology wise or whatever else people speculate about when choosing between crypto assets.