Cryptocurrency trading is becoming an increasingly popular way for investors to make money. Traders can access cryptocurrency markets 24/7 and the relatively high volatility means there are plenty of opportunities to profit from bitcoin’s price fluctuations.
This article will serve as an introduction to cryptocurrency trading, outlining what a cryptocurrency is, how you can invest in these assets and how you can trade their price fluctuations.
What is a Cryptocurrency?
A cryptocurrency is a digital asset that is secured by cryptography and shares many of the features for an asset to be considered money.
While cryptocurrency is not an entirely new concept, it wasn’t until the release of Bitcoin in 2009 that the first decentralised, digital currency came into existence. Satoshi Nakamoto managed to solve the Byzantine General’s problem - which impeded the creation of a peer-to-peer cryptocurrency without falling victim to the 'double spending'.
Cryptocurrencies like bitcoin are open source and permissionless, meaning that anyone can contribute improvements and no-one is restricted from using bitcoin. No government, entity or organisation has control over bitcoin and this is one of the reasons why cryptocurrencies are attractive to investors, because changes to the protocol requires miners, users and developers to coordinate.
As an asset with a fixed supply, it is thought that bitcoin will become a store of value like gold. Cryptocurrencies are also increasingly becoming used as a form of payment given that they are easily transacted across borders, entail lower fees as compared to the legacy banking system and there’s no possibility of charge-backs.
How Can I Invest in Cryptocurrency?
You can buy cryptocurrencies like bitcoin and ether from exchanges, online vendors, cryptocurrency ATMs or on peer-to-peer marketplaces.
If you invest in cryptocurrency, make sure to educate yourself about security and storage. Any cryptocurrencies left on an exchange or custodial service are at risk of being lost or hacked. If you do not control the private key, then the cryptocurrency is not really under your possession.
You can store cryptocurrencies in a wallet - the main reference client wallet (e.g., Bitcoin Core for bitcoin) and cold wallets (hardware and paper wallets) are highly recommended if you want to invest in cryptocurrency for the long-term. If you buy cryptocurrencies from an exchange, withdraw them to a wallet you control.
How Can I Trade Cryptocurrency?
Cryptocurrencies can be traded in one of three ways:
- Spot trading: buying bitcoin at a low price in terms of USD and sell for a higher price, netting a profit in USD (or sell bitcoin at a high USD price and buy back lower).
- Margin trading (or leveraged trading): traders go long or short using margin to trade more than their account balance, amplifying their profits (or losses).
- Altcoin trading: buy altcoins at a low price in terms of BTC and then sell for a higher price, netting a profit in BTC.
To trade cryptocurrency, you will need to sign up to a cryptocurrency exchange which is similar to a traditional exchange like the NYSE or Nasdaq. Most cryptocurrency exchanges take custody of their user’s funds and perform trades on their behalf.
Once you deposit coins to a cryptocurrency exchange, you can then use the platform to buy and sell. When you submit an order, you are giving the exchange permission to act on your behalf and buy or sell bitcoin.
There are different types of cryptocurrency exchanges including:
- Fiat-to-crypto exchanges: These exchanges allow you to deposit fiat currency (such as the USD) and exchange for cryptocurrencies. An example of a fiat-to-crypto exchange is Bitstamp.
- Crypto-to-crypto exchanges: These exchanges allow you to trade cryptocurrenices (such as bitcoin) against other cryptocurrencies (such as Tether or ether). Interdax falls under this category. A good example of a crypto-to-crypto exchange is Bittrex.
- Derivatives exchanges: You can trade cryptocurrencies using margin and enter positions that are larger than your account balance through the use of borrowed funds. Interdax falls into this category.
While there are different methods you can use to trade cryptocurrency, there are also different trading styles. You will want to figure out which style suits you best before beginning to trade:
- Scalper: these traders use low timeframe charts (such as the 15-minute or 5-minute charts) to enter positions for a very short amount of time and profit from small fluctuations that happen on a minute-by-minute basis.
- Day trader: day traders typically enter and exit positions within a particular daily trading session. These traders capitalise on intra-day movements and typically use the 15-minute, 1-hour and 4-hour charts.
- Swing trader: These traders enter positions and intend to hold them for a few days or for a few weeks to capture a significant portion of a move in the markets.
- Zen trader: these traders use high timeframe charts (such as the weekly or monthly charts) to enter positions with a very long time horizon, profiting from moves that unravel over weeks, months or even years.
As a new trader, you should test your strategies using the testnet version of an exchange or a demo platform. Once you have collected data on your performance, the most important things to consider are your average profit and loss and the risk taken on each trade.
Before you trade with real funds, you should figure out what level of risk your strategies are able to handle without blowing up your account. You will also need to figure out your average profit and loss; if it’s not positive then you will need to reassess your strategies.
What Techniques are Used by Cryptocurrency Traders?
There are three main tools in a trader’s toolkit;
- Fundamental analysis,
- Sentiment analysis, and
- Technical analysis.
You can combine them together or focus on them individually to trade cryptocurrency.
Fundamental analysis refers to anything that is related to the intrinsic value of a cryptocurrency. As a new and emerging field, the study of cryptocurrency fundamentals is not as established as fundamental analysis for traditional assets such as stocks or currency pairs like USD-JPY. Most of the fundamental analysis for cryptocurrency revolves around the concept of network effects but also includes things like fees as a proxy for demand.
Sentiment analysis refers to how market participants are feeling and is a contrarian indicator. If everyone feels bullish and wants to go long, then that is often a sure sign that the market will do the opposite. When sentiment reaches an extreme, it usually correlates with a top or bottom in the price of an asset.
Technical analysis is the use of price action, patterns and volume to predict the path of future prices. As the saying goes, history tends to repeat itself. Technical analysis can be applied the same way to cryptocurrencies as it is applied to traditional assets. Given that the cryptocurrency markets are open 24/7, some indicators may need to be optimised to account for the continuous nature of cryptocurrency trading.
To summarise, a cryptocurrency is a new type of money that is digital, secured by cryptography and is not controlled by a single entity.
Cryptocurrencies are traded on exchanges, where you can trade bitcoin against fiat currency (like the USD), other coins (such as ether) or trade bitcoin using leveraged positions.
Be sure to test your strategies before trading with live funds and figure out what style of trading suits you best and learn as much as you can about different types of analysis and the characteristics of the asset you are trading.