The invention of Bitcoin, Ethereum, and other cryptocurrencies has ushered in a new asset class that has proven lucrative for many traders.
Firstly, we need to make the distinction between investing and trading – the biggest difference being the time horizon. With trading in any asset, the time horizon tends to be short-term and often more speculative in nature. It is not uncommon for traders to execute dozens of trades a day to take advantage of intra-day price fluctuations.
Trading is approached with discipline as those who are most successful carefully manage their exposures. With investing, it is also a disciplined plan but meets specific financial goals over a longer period of time, usually five years or more. Investors may build a strategy in order to save for college, buy a house, or plan for retirement.
In this article, we will focus on trading in cryptocurrencies. Like most things related to cryptocurrency, trading cryptocurrency can seem to be intimidating or confusing. However, cryptocurrency trading platforms have made it easier than ever to trade cryptocurrency instantaneously around the world.
Further, these platforms have made trading cryptocurrency a similar experience to trading other financial assets like stocks or bonds through user interfaces that are either similar to or exactly the same as their traditional online trading platforms.
Trading cryptocurrency differs from investing in cryptocurrencies because of the time horizon of the trade.
To trade physical cryptocurrency, one needs to have an account with a Centralized Crypto Exchange or a Crypto Broker.
To trade cryptocurrencies, traders use a variety of techniques based on careful analysis and quickly adjust to changing market conditions.
How to Start Trading in Cryptocurrency
In order to start buying and selling cryptocurrencies, you can transact with Centralized Crypto Exchanges (“CEX”), Decentralized Exchanges (“DEX”), and via Crypto Brokers. Popular Crypto Exchanges are Coinbase, Crypto.com, Gemini, and SoFi. Examples of DEXs include Uniswap, PancakeSwap, dYdX, and Kyber. Some of the most popular Crypto Exchanges are Coinbase, Crypto.com, Gemini, and Binance. Each of these channels has its own pros and cons that we cover in detail here.
If you decide that you want to hold the cryptocurrency yourself, you may also need to decide the best type of wallet to use. Crypto wallets help store the precious private keys that allow you to prove your ownership of the digital asset, which is always stored on the blockchain.
We have also seen standardized futures markets pop up for Bitcoin and other more liquid cryptocurrencies, such as Ethereum. These futures markets allow institutional investors to trade contracts, or agreements, to buy and sell cryptocurrencies at a pre-agreed later date in a developed and transparent manner via established exchanges.
It allows investors to not only buy a future claim on a digital currency but also take a negative view of that cryptocurrency and sell it short. These futures are cash-settled, and by going through an exchange, trades are conducted in an established and regulated marketplace.
You may also choose to invest in cryptocurrency via specialized Exchange Traded Funds, called ETFs for short, that invest specifically in Bitcoin and other cryptos. An ETF is sort of like a mutual fund but is bought and sold over an exchange, so they have decent liquidity.
ETFs have been around for a long time and tend to be very lightly managed, instead of tracking the performance of an asset or an index, and as such, normally charge lower fees than a traditional mutual fund. ETFs try to mimic the performance of the underlying cryptocurrency.
Cryptocurrency Trading Strategies
Trading cryptocurrency can involve many strategies, similar to that of trading any other financial asset. It means that the first thing to note before trading cryptocurrency or crypto assets is to do research and conduct due diligence. Simply listening to a friend’s hot tip or buying digital assets out of the Fear-of-Missing-Out (“FOMO”) is not recommended.
For any crypto-asset investment, it would be wise to read the whitepaper in order to better understand the cryptocurrency’s purpose, technology, and use case. Understanding the team also gives you a sense of the track record of the people responsible. Ultimately, given the lack of regulation and oversight in digital assets, you want to avoid the risk of trading a crypto asset that collapses due to fraud.
One of the most well-known and used trading strategies is to use technical analysis (“TA”). Simply put, technical analysis aims to identify trading opportunities by analyzing trading activity statistics such as price movements as well as changes in buying and selling volumes by using corresponding charts.
Despite its limitations, the TA approach gives traders a set of tools about how market psychology impacts the demand and supply of an asset and how that impacts the asset’s price. This psychology is anchored in the belief that asset prices move in observable trends and that history tends to repeat itself.
By using technical analysis, you can determine price ranges for a cryptocurrency that represent a purchase or a sale – called Range Trading. You may also use TA to determine the intraday momentum behind an asset’s purchases or sales to determine whether to buy or sell – a popular day-trading strategy called momentum trading that believes “the trend is your friend.”
Some crypto traders believe in contrarian trading strategies, based on the idea that a crypto asset whose price has been steadily rising or falling is due for a correction. They look for signs of an impending reversal in price direction using TA indicators to determine when to buy or sell.
Another popular cryptocurrency trading strategy is called Scalping, which looks to use frequent, but smaller trades that are closed once it shows a small profit. These trades may be held for a few minutes before being closed out and scalpers may trade many times a day. Again, these types of traders use TA, sometimes down to 1- or 5-minute intervals, to determine when to place or close trades.
Once a trader wants to buy or sell a crypto asset, they can either execute that trade at the market price or at a different price target. Market orders are filled at the prevailing bid or ask price. Limit orders only execute the order if and when they get to a certain level. Obviously, buy orders are set below the market price and sell orders above.
Additionally, traders use stop-loss limit orders, which are executed as a market order when the price of the asset falls below the stop price. The opposite trade is called a take-profit trade, which are orders that are executed as a market order when the price of that asset (hopefully) rises about the take-profit limit. All orders other than market orders are left with a time deadline and, in some cases, left as a “good ’til canceled” order.
Regardless of whether a trade is done by market or limit order, the CEX or crypto broker will charge for their service, so more frequent trading is likely to eat away at any potential profits.
Another service that CEXs and crypto brokers may provide is leverage via margin accounts, which uses borrowed money from either the CEX or crypto broker to increase the exposure to an investment and amplifies both potential gains as well as losses. These lenders will charge interest on the borrowed funds and will require the borrower to maintain margins to protect against the price of the asset falling.
Thank you for reading CFI’s guide on How to Trade cryptocurrency. To keep advancing your career, the additional CFI resources below will be useful: