What is cryptocurrency trading?
What is Cryptocurrency Trading?
What you'll learn?
- What cryptocurrency trading is
- The nature of risk in trading crypto
- The difference between trading vs hodling
- The importance of keeping your feet on the ground
When we surveyed newcomers to cryptocurrency asking them what aspect they would most like to learn about, one of the most popular answers was how to trade cryptocurrency.
This shouldn’t be a surprise. Cryptocurrency is an ideal asset to trade because its short-term price is volatile. In other words, price changes quickly and by significant amounts on a regular basis.
A volatile asset presents a lot of opportunity for traders who make money by exploiting price movement; but trading cryptocurrency is a double-edged sword. Greater volatility means greater risk, and the risk to a novice trader of losing money is much greater than the chance of making money.
Cryptocurrency is also a novel and relatively immature asset, which means that its true potential over the longer term is especially hard to predict.
Early investors have enjoyed astronomical returns, and because adoption is still at a relatively low level, cryptocurrencies still present the possibility for significant returns relative to investment.
Its novelty - especially in relation to its challenge to traditional forms of money - means its use case and legitimacy in the eyes of governments are unproven, and so there too, lies a lot of risk, to weigh against the opportunity.
Distinguishing Trading From Investing
So cryptocurrency is a risky, novel and volatile asset, but with significant potential upside in both the short and long term. Your challenge is to figure out how to tap into that potential, manage the risk and make money, by learning how to trade cryptocurrency.
To keep things simple at this point, let’s assume that what we mean by making money from cryptocurrency is selling it for more than you bought it for (later in this section we’ll explain that it is potentially much more complex than that) and use Bitcoin as an example.
With this in mind, and thinking about the two broad approaches to profiting from cryptocurrency we’ve introduced, think about these two questions:.
- Will bitcoin’s price go up or down over the next 24hrs?
- Will bitcoin’s price go up or down over the next 4 years?
Both questions require you to risk your money predicting bitcoin’s future price movement, which is uncertain. The crucial difference is the time frame, as this makes you think about that uncertainty, the risk to your investment, differently.
The reason for this is because what influences bitcoin’s price over 24hrs, is different to what influences its trajectory over four years.
Yes, the 24hr chart is a subset of the four year chart, and in aggregate daily changes will smooth out to form long term patterns, but you cannot make a long term forecast based on what happens on a given day, and visa-versa.
The factors that influence long term change are different to those that influence short term change.
When we talk about buying and selling over short periods of time we are talking about Trading. Making frequent bets on short-term price movement.
In contrast buying and then passively holding for an extended period of time to then sell for a profit is considered Investing.
The world of Bitcoin has even come up with a term that describes the determination to hold the asset over the long term - Hodling.
So if your interest is in making money from cryptocurrency you need to understand the distinction and the different decision-making processes associated with each.
You don’t have to choose, you can be both a Trader and Investor, or neither, so long as you appreciate the difference and separate your activities..
Trading vs Hodling
Though both Trading and Hodling require you to manage risk, it plays out over different time frames - short term and long term - and the influences on risk - how it manifests as price movement, and the approaches to managing it - are different for each.
The umbrella term for analysing short-term asset price movement and volume of trading is Technical Analysis.
Taking a much broader look at the influences on future success of the asset and measuring risk through factors that play out over a longer period of time is referred to as Fundamental Analysis.
Fundamental and Technical Analysis can overlap, but they provide a useful framework for separating trading from investing. But both approaches still come down to measuring risk.
So the basis of this section on learning how to trade cryptocurrency will start by looking at the decision making process:
Technical Analysis - Understanding price and where it comes from; reading price data & price charts; interpreting historical trends; learning about volume & key price indicators
Fundamental Analysis - Understanding crypto's key adoption/performance/health metrics; price correlation with the wider economy; available adoption/price models
Risk Management - how to measure risk; risk and trading size
Once you’ve understood the concepts around decision making, we’ll move on to execution:
Making your first trade - Learning how to actually place a trade, based on your assessment, and the complexities around that.
Advanced Trading Topics: Once you have learned the basics, we can introduce more complex and riskier trading tools which can increase your exposure through leverage or by speeding up the execution process through automation.
Feet on the Ground
Whether Trading or Hodling, you are essentially betting that you will be able to sell a cryptocurrency at a higher than the point at which you bought. You might flinch at use of the word ‘betting’ but trading is a form of gambling.
The trick is reducing it to a skill-based decision - through a structured approach - and tilting the odds/risk in your favour.
If you simply open an account with an exchange and place trades based on nothing but instinct, or a random tweet you read, it becomes a luck-based process.
You may as well be flipping a coin, except that the odds will be against you (as will be explained) and you will almost certainly get burned.
You can think of learning to trade like learning to play poker. You face a steep learning curve with the likelihood that the experienced players will take advantage of the novices.
This is known as the Pareto Principle - the majority of profit will be generated by a minority of participants. The learning curve gets steeper in relation to the potential returns.
You need to have your eyes open and feet on the ground to stand any chance of being successful, especially if you want to trade rather than invest. The majority of traders blow up in their first year, and that isn’t just because they fail to understand the basics of how to trade cryptocurrency and the Pareto Principle, it is because they fail to understand themselves.
Trading requires knowledge and mathematical discipline - crunching numbers and trying to find an edge against the market - but just as important is having clear objectives and psychological discipline.
You cannot expect to buy at the exact bottom and sell at the top. This tweet summarises how fleeting the highs of the Bitcoin market have been.
Instead you need to set realistic expectations, and if you start active trading, record your actions in something called a Trading Journal.
Psychological discipline starts with being honest with yourself about what you are trying to achieve and how - a Trading Journal plays a key part in that. As a complete novice, the likelihood that you’ll become rich overnight is tiny, the equivalent to winning the lottery. So start with realistic expectations.
If you were learning to drive a car would you just follow a few online tutorials then hit the motorway? Trading, like learning to drive a car, is a risky activity that requires the right kind of preparation.
A successful trader will be happy simply making a return above what they could derive from their capital otherwise - the opportunity cost also known as discount rate.
They are not looking to knock it out of the park with every trade, and many of their trades will end with a loss. You need to be able to understand and accept that.
If you feel uncomfortable making losing trades and overcome by a desire to try and immediately regain losses, you aren’t cut out for trading (or any other form of gambling).
It is equally important to separate luck from skill. Being on the right side of a trade doesn’t mean you’ve cracked it, unless you can satisfy yourself that you weren’t just lucky. It is very easy to post-rationalise a trade and attribute success to your approach rather than simply being lucky.
If you put enough monkeys in front of a typewriter one of them will eventually produce the Bitcoin Whitepaper. This doesn’t make them Satoshi Nakamoto. It's called Survivorship Bias and the same applies to trading. It is one of a host of behavioural biases that impact effective decision making and can lead to failure.
As we’ll see later in the section, there are different types of Trader, the key differentiator is the amount of time you are able to dedicate to doing proper research. Your trading frequency should be in direct proportion to the time you can dedicate to analysis.
If you haven’t been put off by that bucket of cold water, the next article will explain where cryptocurrency prices come from.