Table of Contents
1. Introduction
Cryptocurrency trading has boomed in recent years, taking up a significant portion of the financial industry. Many individual traders are diving into trading cryptocurrencies, in hopes of turning their investment into large amounts of money. While there are many success stories from cryptocurrency traders, the market itself is incredibly volatile and has big risk for losing substantial amounts of money. It isn’t uncommon to hear about a trader who’s earned some Bitcoin and/or altcoins, and sold them for a huge profit. It’s also possible to enter the market too late when the prices have already gone up and there is no more ROI. There’s also the case of an investor losing a large amount of capital in a short trade. This guide serves as a useful primer to those just beginning to educate themselves in the world of cryptocurrency trading.
1.1 Overview of cryptocurrency trading
High variability assets like cryptocurrency are usually best off traded on a short-term basis, but given the uncertainty in the price, no specific method is concrete. This is somewhat of a pro and con, and the decision can be made dependent on the context of the market and the desires of the trader. With such a variable spread of methods, it’s important to consider the most appropriate means to gather speculation, as a method that does not suit the desired return may result in opportunity cost.
Most coins can be traded on an exchange, but there are a few, like bitcoin, that have an associated trading platform. This can be due to fragmentation of the coin for reasons like splits or not built any further than a primary blockchain. In these cases, CFD trading can prove to be a more cost-effective and easier way to speculate on price movements. It is vitally important to understand the various ways and means of trading cryptocurrency in order to guarantee maximum returns with minimum wastage. Since the true value of the coin, or the underlying asset, is still a wild variable, the main method of trading is through forming a speculative assumption on the price and alongside it an expected return with a desired cut-off point. Understanding the various methods and within them the various strategies would take a good deal of time, but it is all time well spent.
Cryptocurrency trading is the act of speculating on cryptocurrency price movements via a CFD trading account, or buying and selling the underlying coins via an exchange. CFD trading on cryptocurrencies is a simple way to start trading as a trader can speculate on price movement from as little as 0.01 GBP without the cost of buying the underlying asset. CFDs are leveraged, so there are cost benefits, but it also carries a high level of risk. We will expand on this later.
1.2 Importance of understanding market trends
Understanding the market tips might help figure out if the trend is going to continue or break. The importance of understanding the market trends in the crypto space cannot be overstated. It’s the primary determining factor in the nature of a trader’s success. The volatility of cryptocurrencies can be quite scary and foreign to most people. Over time, with trends showing a steady increase in value and little to no price volatility in downward value, it can be assumed that the cryptocurrency is becoming more of a stable investment compared to its prior price action. During times of steady increase with little price volatility, the reasoning for remaining a spot trader increases. Making long-term investments in cryptocurrencies permits one to leverage less risk compared to day trading or using leverage trading to attempt to increase crypto holdings. For day traders or leverage traders, identifying trends is crucial in attempts to buy low and sell high. This practice is a primary form of market trading in any investment vehicle, and it is netting much higher returns compared to holding a single asset of cryptocurrency during an uptrend. An alternative to this, selling short is a practice where one can borrow a stock or, in this case, cryptocurrency from a broker and sell it with the agreement to buy it back at a future date. If one expects the price of the cryptocurrency to decrease, selling it at a high price and buying it back at a lower price is a net positive for the trader. However, this is quite risky in itself, where the chance of a price increase could cause a margin call or force the trader to buy back the cryptocurrency at a higher price still.
1.3 Risks and rewards of trading on crypto
More often than not, a large majority of current speculators have little to no knowledge of altcoins. This leads to impulsive and emotionally driven trading without a concrete plan. The strategies of HODL (hold on for dear life) and ping pong trading, buying high and selling low, or vice versa, based on the opposite trend, are commonly executed with mixed results. Failure to conduct proper research often results in players getting trapped in negative equity, as their encrypted contents are lost forever. This can lead to a feeling of hopelessness, which is the ultimate downfall for traders and serves as a testament to the importance of knowledge. Buyer’s remorse occurs when altcoins show valuable movement, and the emotionally driven trader begins to question their decisions. They may then sell at a loss in the hope of regaining their losses and moving towards a coin that has proven to be more valuable in the long term.
Similar to trading on the stock market, the goal is to buy low and sell high, or vice versa. This principle also applies to trading foreign currencies for international business. Stock prices are constantly fluctuating, and there are times when they become overvalued or undervalued. By using tools such as technical analysis or staying informed about popular news, whether political or economic, traders attempt to predict future trends in order to make profitable trades. This understanding is crucial for both buyers and investors to have a solid grasp of what lies ahead. Unfortunately, this is not always the case, especially when it comes to cryptocurrency and altcoins.
The concept of trading on cryptocurrency has taken the globe by storm. Many individuals are concerned about the current economic slump and are looking for alternatives to improve their financial situation with the potential for significant profits. Crypto is one of the options that offers these seekers the opportunity to secure their future with attractive income through a relatively simple and easily understood investment approach. However, it is important to recognize that while the potential rewards are great, there is also a darker side to consider.
2. Fundamental Analysis
Management is a key determinant of value for any company. It’s important to assess the quality of the team behind the cryptocurrency, in terms of technical skills and the ability to carry out a business plan. Again, this might require some more in-depth research and it may be worth looking to see if team members have LinkedIn profiles, or long and successful histories in previous occupations in similar fields. Red flags include anonymous teams, or those for which it is difficult to find any information. The age and diversity of the team can be a factor, and part-time only developers are not preferred. The best-case scenario here is finding a cryptocurrency with a strong team and full-time employees, where the value of the coin can somehow be tied to the success of the product. It could be said that marketing a product is also part of its intrinsic value. Consider the professionalism and quality of marketing, a company that values its appearance and has a clear plan is more likely to provide a product of value.
Assessing the team behind the cryptocurrency
Due to the fact that anyone can create an ERC20 token in a matter of minutes and the majority of cryptocurrencies have no actual product, it can get quite difficult to differentiate between what is a valuable long-term investment and what isn’t. In cases such as these, it’s important to assess whether the cryptocurrency has addressed a real-world problem, and if decentralization is a necessary part of that solution. Coins which are simply forks of existing cryptocurrencies or have a slight tweak on the original indicate that there is very little thought put into the product and are often designed with the intent of making a quick profit. In this case, the value could be in the technology itself. It may be worth investigating whether your chosen cryptocurrency is actually superior to what it’s looking to replace, and whether it’s technically sound from an IT standpoint. Whitepapers and documentation on repositories such as GitHub are a gold mine for this kind of information. High-quality and professional documentation is often indicative of a high-quality product. A more technical understanding of the technology may be required for this kind of assessment.
Evaluating the underlying technology
Fundamental analysis is a method of evaluating a security in an attempt to assess its intrinsic value, by examining related economic, financial, and other qualitative and quantitative factors. It can prove as an extremely valuable tool when trading cryptocurrencies, given that there is no inherent value in the majority of them. The three main aspects of fundamental analysis to consider for cryptocurrencies are outlined below.
2.1 Evaluating the underlying technology
This stage is all about understanding the real value of the project. With more than 1500 cryptocurrencies in the market, it’s very difficult to analyze each one of them. But the starting point is the white paper. A white paper is the bread and butter of any ICO. Despite the project idea, a high-quality white paper will explain the business use, the tech behind it, and how it will be sustained. From the white paper, you can then start to dissect the project to see if it’s genuine or not. If you’re not a tech-savvy person, it might be difficult but worth asking someone who is to understand if the project is technically possible and how it can be done. If the white paper explains a vision on a product but lacks technical info or depicts a product that is not feasible, this is a warning sign. Next, you can then try and see how innovative the technology is. Is it a new idea and utilizing tech that has never been done before, or is it a reiteration of an existing product? If it’s the latter, the technology will most likely have no lasting effect and will not increase demand and adoption of the product. Step three is to look at the roadmap and see if the product is structured correctly. A well-planned roadmap, with attainable goals and benchmarks depicting the progression of the technology, is a good sign. A vague roadmap with the sole purpose being a crowdsale is a very common sight and a tactic to make a quick buck. Finally, the fourth step is to look for a prototype or MVP (Minimal Viable Product). Seeing is believing in this world and if you can get your hands on a prototype, you can see if they are making any tangible progress. A project with visual or tangible results at the time of crowdsale will likely increase the token value as it instills confidence in investors.
2.2 Assessing the team behind the cryptocurrency
Fundamental analysis can be especially pertinent to trading cryptocurrencies. As criticisms of cryptocurrency perhaps not being backed by anything more than a complex algorithm circulate, it’s no surprise that investors would want to ensure they’re putting their money behind something with real substance. Assessing the level of competence and trustworthiness of the developers can be difficult to gauge. The first port of call would be to look at a coin’s official website. Look into what specific skill sets the team has. It’s likely developers will be qualified in one of the following – computer science, data programming, computer engineering, mathematics, and/or statistics. The more technical the skill set, the higher the probability they can produce something of value. It would be smart to click through to LinkedIn profiles where possible, double-checking the team has in fact worked on related projects or possesses the skills they claim to have. While it’s not uncommon for a skilled programmer to have nothing more than a couple of code samples on GitHub, the best-case scenario would be to find an experienced developer with a verifiable track record in the tech industry. The less transparent a team is with their personal details, the less likely the coin is to be a safe investment. Bear in mind the ICO craze has allowed developers to earn life-changing amounts of money through nothing more than a whitepaper. It’s highly desirable to find a team that is personally invested in the project, either through proof of work or their own stake of coins. This shows they have something to lose if the coin doesn’t turn a profit and will be motivated to make sure the coin is a success. Any level of success in this scenario would likely translate to an increase in the coin’s market cap and result in a profitable return for early investors.
2.3 Analyzing market demand and adoption
In an economic context, demand is the force that moves price and is reflected by a curve. The inverse is also true: a movement in price can only be explained by a change in demand. Demand for a cryptocurrency can be identified through a variety of methods. The most basic one is directly asking people if the cryptocurrency in question has an effect on their purchasing decisions. This method is highly subjective and depends on the person’s understanding of the cryptocurrency and industry. Thus, the data collected from this method may not be reliable or easily translated into the purchase of cryptocurrency or shift of foreign exchange (more on this later). Another similar method is to look at the cryptocurrency in comparison to other forms of money (stocks, bonds, forex) and try to identify if there is some form of income (i.e., use of money) or substitution effect. For a more direct and objective analysis, market data can be used to study the relationship of cryptocurrency sales to changes in price. Unfortunately, many in the cryptocurrency space don’t truly understand basic economics and may not know what effects a change in price. This makes consumer surveys and interviews with industry experts an especially valuable tool for understanding elasticity and forecasting changes shifts in the demand curve. A demand schedule of the quantity of cryptocurrency that will be bought at various prices can be developed in the long run.
3. Technical Analysis
Technical analysis of prices utilizes the information encompassed in patterns of price movement as a predictive tool for the next price trend, providing a trader with an ‘edge’ (i.e. an indication of a higher probability of prices moving in one direction rather than the other). The method employs a series of techniques to evaluate price movement, as well as price trend. These techniques are focused on two distinct aspects of price movements. The first is the study of the patterns of price movement to the past with the assumption that the past movement predicts the future movement. The second is the evaluation of the price trend with the use of trend lines, which act as a measure of the rate of price movement. The aim here is to identify a trend that can be traded in the anticipation that it will continue. Prices can move virtually in any direction (i.e. upwards, downwards or be stagnant) and it is also necessary to determine the direction of the trend. For traders following a trend following strategy, it is necessary to identify the direction in which the price is moving. If the trend is identified then it becomes a matter of importance to continue to identify successive higher highs and higher lows for an uptrend, and lower highs and lower lows for a downtrend. As a future trend change is anticipated if a price reaches a certain level, most commonly a trader will make use of trend lines to increase trade probability by ensuring that the trend line is not breached in the case of an uptrend, or to consider taking an exit or reversal of trade if the trend line is broken in the case of a downtrend. Trend lines can be used to trade trend change or entry/exit in ranging markets.
3.1 Understanding chart patterns and indicators
As a general rule, when the price of an asset is above the moving average, it can be seen as bullish and the price of the asset may continue to rise. However, when the price of an asset is below the moving average, it can be seen as bearish and the price of the asset may continue to fall.
By far the most popular indicator in all of technical analysis is the Moving Average. Moving averages are a lagging indicator. This means that they can only predict future prices because they are calculated using past prices. This can either be very useful or utterly useless to trading depending on the time frame and the quality of the data. There are two main types of moving averages: the Simple Moving Average (SMA) and the Exponential Moving Average (EMA). The main difference between the two is the way that they’re calculated. The SMA takes the mean average of an asset’s price over a set period of time. This period of time is up to the individual user, although it is default set to 30 days. On the other hand, the EMA assigns greater significance to the most recent prices in an attempt to reduce the lag of the moving average. This is done by assigning a weight to each price, often starting at 2 and doubling for each previous period. Then, this figure is used to divide the number of periods selected by the user.
Patterns can be split into reversal patterns and continuation patterns. A reversal pattern signals that the trend in the price of an asset is about to reverse. An example of a trend reversal is a bullish Head and Shoulders. When this pattern occurs, it is a signal to sell the asset and buy it back when the price is lower. On the other hand, a continuation pattern shows that the trend in the price of an asset will continue, meaning there is no need to sell an asset and may provide an opportunity to buy more. An example of a continuation pattern is a bullish Pennant. When this pattern occurs, it is a signal to buy more of the asset and there is generally no need to stop buying until the pattern completes.
Technical analysis involves utilizing various patterns and indicators to predict the future price of a cryptocurrency. The main principle behind technical analysis is that the price of an asset will move according to predetermined trends and will do so in recurring patterns. By learning to identify these patterns and the signals they generate, the cryptocurrency trader can increase their probability of making a profitable trade.
3.2 Identifying support and resistance levels
Support and resistance levels are a concept from chart or chart pattern that are determinants of the change in trend and trend continuation. A resistance is a level on a chart that has a price increase that will not go any higher. This can be due to various factors and does not matter why the price has stopped, only that it has. For a level to be classified as a resistance, it must have at least two touches of high that are connected with a line. To validate a trend change, there must be a break of the last upward move. If this is a strong upward move, there may not be a trend change, just a continuation, so it is important to define the move first. A break of the move will show that the new downward trend has started, and when the price comes back to this level, the player can look to enter a short trade. An example of a strong move and a continuation of the trend would be if the price was to go past the point of the strong upward move. The move would then become a support as the trend has changed. The reason for this is that support and resistance are trend subjective and are a reflection of all the other methods. Drop and back is what I always recommend to trade with. This is due to the fact that it is a pending order and simulated in the market. If the trade goes wrong at any point, it can be cancelled with no risk whatsoever. A stop order trade can be done when the price comes close to the resistance and starts to turn. The stop order is valid until the price is broken through and is then cancelled. Risk is managed on this trade when the price reaches the low of the last move. A scaling method can be done with the pending orders when the price is getting closer to the point. There are many reversal trades that can be taken with small contracts.
3.3 Utilizing trend lines and moving averages
Both trend lines and moving averages are used to identify the direction in which the market is moving. They also help to identify when a trend is reversing. This is a crucial piece of information as it helps to maximize the profit on winning trades and limit losses on losing trades. A trend line is a sloping line used to predict the direction of an asset. Drawing a valid trend line is something that takes a fair bit of practice. The line must pass through as many of the wicks as possible without crossing through any candles. The steeper the trend line, the higher the momentum at a given point in time. If the trend line is broken, it can be a strong indicator that a trend is reversing. Depending on how you draw them, trend lines can show an overall direction or a direction at a given point in time. Moving averages are one of the most popular forms of technical analysis. They smooth out past data to form a trend-following indicator. They lag because they are based on past prices. The longer the time period for the moving average, the greater the lag. Long-term investors will use a long period such as 200 MA in order to smooth out all the bumps and noise in a volatile market. The only direction for the moving average line to show a trend is for it to be sloping, so if there is no clear direction, then there is no trend and no need to trade. When the price moves above the moving average line, this is a buy signal, and when it moves below, a sell signal. Moving averages can also act as support and resistance; in an uptrend after a reversal, the price will often come back down to the moving average to find support before continuing.
4. Risk Management
A take-profit is the opposite of a stop-loss and is used to secure a profit by selling at a pre-determined price. This is useful in the same way as a stop-loss when there is no time to monitor the price but will also prevent greed. Emotions are often the enemy of traders and can lead to making impulsive decisions. Whether it be panic-buying on a peak or being too slow to take action in a changing market, setting these simple orders will add a great deal of discipline to any trading strategy.
A stop-loss is an order to sell a certain amount of cryptocurrency at a pre-determined price. The primary use of a stop-loss is to mitigate a worst-case scenario. In volatile markets, it is possible that the price crashes so fast that it is hard to react in time, therefore the stop-loss will ensure that the order is executed even if you are not at your computer. An example of a bad scenario is buying a cryptocurrency for 1 BTC at $400 only for the price to start rapidly decreasing. If the investor has no stop-loss and the price reaches $200, he would have lost half of his investment. If there was a stop-loss set at $350, the investor would have only lost $50.
Trading cryptocurrency is a high-risk investment due to market volatility. Therefore, it is essential to know how to act in certain situations. Risk management is a broad topic and each of the sub sections in this article will be a topic on its own but we will go through a general idea of what it is to manage risk while trading cryptocurrency. Setting stop-loss and take-profit levels is fundamental.
4.1 Setting stop-loss and take-profit levels
Take-profit works much like a stop-loss order but in reverse. It is an order to buy or sell a financial instrument once it reaches a certain price that is more profitable than the price at the time the order is made. Take-profit is measured in the same price or in pips. This is a good tool for both long-term and short-term traders as it gives the evidence needed for a trade exit. Long-term traders may set their take-profit levels and not check the market until they have realized their profit, or unless there is a strong change in the fundamental reasons for the trade. Short-term traders often do not know what the global outlook is beyond a few hours. For them, take-profit can be an informative way to construct a trade exit. A technical trader might only exit when they see a strong counter-trend pattern. Take-profit can also work for swing traders. If a currency has sustained a high move and looks to have established a strong trend with a high probability of continuation, then the trader can move their take-profit order to reflect the increased probability.
Stop-loss is a convenient way to minimize losses if the market moves against your position. It is an order to buy or sell a given amount of a financial instrument at a specified price or better. It is a simple ‘bare bones’ risk management technique and can be an effective way to avoid margin call and stop out levels. It is generally recommended that you use a stop-loss order. Such a tool would allow a trader to specify the amount of pips before the trade would be closed. Using leverage and shorting can compound risk and it can be very easy to lose all of an investment if a strong trend develops. In this case, setting a tight stop is advisable.
4.2 Diversifying investments across different cryptocurrencies
An alternative method is investing in ICOs or new coins/tokens as early investment can lead to significant gains. The risk here is that many ICOs fail and coins can end up worthless. Money in this sector of investment should be considered speculative and only a small percentage of the portfolio should be risked. This is the approach of high risk high reward, or as the saying goes “you’ve got to be in it to win it”.
One method of diversifying is investing in different types of cryptocurrencies, or different sectors within the cryptocurrency space. For example, a trader could choose to invest in Ripple and Monero, as Ripple is attempting to become a decentralized payment settlement system for banks while Monero is a privacy-focused currency which has gained recent traction in the darknet market. The two coins serve different purposes and are not in direct competition, so it is less likely that the value of one will affect the other. Another example would be investing in a range of platform ICOs as each has a different and unique value proposition.
Spreading investments by diversifying the portfolio is a strategy used by traders to mitigate the risk of a single loss having a severe impact on their investments. The idea is that gains in one area can compensate for losses in another. Diversifying a cryptocurrency portfolio involves investing in a range of cryptocurrencies in different market sectors. This can prove difficult as the cryptocurrency market is generally driven by the performance of Bitcoin as many altcoins are traded against it.
4.3 Managing emotions and avoiding impulsive decisions
Identify primary driver: All decisions are always based on either minimizing pain or maximizing pleasure. Whenever you are about to make a trade, be it going long, short, selling, etc., you need to ask yourself, ‘Am I doing this to avoid pain or to gain pleasure?’ This is important because if the answer is the latter, you are probably about to let a subjective state of mind influence your objective decision-making process, which will often lead to a bad trade. This is really a thinly veiled attempt to rationalize a trade when the real motivation is based on an emotional bias. If an impending trade has the potential to cause an emotional state such as anxiety, fear, or greed, this indicates that the trader believes it will be a good way to maximize pleasure. Trading when in an emotional state is a recipe for disaster. All decisions in that state will be based on impulse, and impulsive decisions are usually bad because they often bypass proper risk/reward analysis and thus often have a low probability of success. So if you always take a conscious pause before all your trades and consider if it’s basically an attempt to either avoid pain or gain pleasure, you can be more aware of your emotional state and be able to quickly identify when you are acting under impulse. At that point, it’s simply a matter of having the discipline to cease trading till the obvious emotional bias has passed.
4.4 Implementing proper position sizing techniques
An ATR value of 150 would usually represent a trade with no impulsive or confirmed signals. ATR values above 150 are considered impulsive and are confirmed on the close of the price bar, traders would add 1*ATR or more depending on the trading method. ATR values below 150 represent a lack of direction in a trade and will result in a smaller position size.
A more advanced method is using the Average True Range to a volatile up and down trending market. Using the ATR, a trader will measure the market’s recent volatility to generate a more accurate stop-loss and position size setting. The system is quite simple and is similar to many stop-loss/take-profit methods. A trader will first move to a higher time-frame, such as a 4 hour or daily, and then calculate the ATR for the prior 14 price bars. Once this step is complete, the trader will move back down to their current time-frame and apply the ATR to the last price.
Position sizing is simply an objective means of adding or reducing a trade’s level of risk. A simple method of increasing or decreasing the risk per trade is using a percentage based allocation which will adjust the amount of currency, or base currency, that you are trading with based on the last closed trade. This method is common among many trading styles including systematic and is a main choice for a mechanical Forex trader.
Proper position sizing is a key aspect in managing risk by controlling the impact of emotions on trading performance. A position size that is too large will increase the emotional impact of price movements. A trader who takes a position that is too small will be faced with the same problem. They may be indifferent to the trade and exit at the first sign of trouble in order to “get it over with”.
