Trading involves holding buy or sell positions for a short duration. Unlike investing, your eye has to be on the market in order to observe sudden changes in direction or behaviour. Often, trading is associated with high risk and while there is the potential to make profit there is also the potential to make massive losses if the proper precautions are not taken. There are many different styles of trading, from scalping to swing trading, momentum trading and more. Each method is design to exploit a specific behaviour of the market.
Here, we talk about how to trade cryptocurrency. Just because we are dealing with cryptocurrency does not mean the rules of the game change. There are fundamentals that never change in trading. For beginners trading in cryptocurrency, the aim is to buy low and then to sell high, or sell high and then buy back low. If you can get this right with cryptocurrencies then you can make profits in a short period of time.. But remember, you can just as easily lose a lot of money, so you really need to know what you’re doing. That’s why you need a strategy.
Types of Cryptocurrency that you can trade
During October 2017, The Chicago Mercantile Exchange (“CME”) announced that they would be creating a bitcoin futures product. What is a bitcoin future? Well, this is a contract whereby a buyer and a seller agree to trade a set amount of bitcoin at a future date, at a price agreed upon today. At the time of delivery (which is the date agreed upon) if the price has risen then the buyer will make a profit of the difference between the price agreed and the new price.
CME plans to release their bitcoin futures product during the early weeks of December 2017. Should they be successful in their launch, it will be the very first time that institutional traders will be able to capitalise on the cryptocurrency frenzy without actually having to own cryptocurrency. Indirectly, this could be a massive step forward for institutional recognition of cryptocurrency. At the same time for the typical day trader there may be an opportunity to trade some renewed volatility in market given that at this current stage indices like the S&P 500 are experiencing record low volumes of trade. Bitcoin futures remains to be an exciting space to watch for potential profit making.
There are also different types of crypto stock that one could trade instead of futures. Crypto stocks are more commonly bought through “ICO’s” or Initial Coin Offerings that are much likened to Initial Public Offerings. The difference between the two is that ICO’s are not regulated. “Investors” receive a “token” in exchange for legal tender or Bitcoin. The Company then raises funds in order to create their proposed product or service. Therefore, your token would indicate your stake of shareholding in the start up. Although this could be extremely lucrative if the correct company is chosen, ICO’s are not without its own set of risks.
Cryptocurrency futures – Bitcoin futures example
Let’s say Ajay and Josh enter into a bitcoin futures contract. The current price of bitcoin is $8000. Josh and Ajay agree to trade 1 contract of bitcoin in one months time for a price of $8500. The price is agreed on now, so in one months time, whatever the actual price of bitcoin is, Josh will have to buy the bitcoin from Ajay for $8500.
After one month the price of bitcoin (the underlying asset) is $10 000. Josh has to purchase it for $8500 and Ajay has to sell it for that price. So Josh makes a profit of $1500 and Ajay makes a loss of $1500. This is the basic concept of how bitcoin futures work.
How to start trading bitcoin futures and other cryptocurrencies
The key to being able to profit from these large moves in these cryptocurrencies is to know when to buy and when to sell, or when to go long and when to go short as it’s known in the world of trading. You need a proven and tested strategy that you can rely on to be profitable over the long-term.
A cryptocurrency trading strategy for beginners
There are 4 parts to a successful strategy:
- Understanding and having an expectation of the price
- Knowing the candle patterns that signal a change in direction
- Understanding how momentum works and when the price has good momentum
- Identifying areas of structure that provide good entry points
Cryptocurrency Price Expectation
Unlike ordinary futures or stocks, crypto assets are far more volatile and having an expectation for the price is absolutely critical.
A simple yet very effective way to determine an expectation is to look at the highs and lows. If the market is continuously making new highs, then we would expect the market to continue doing so until it makes a new low. You will find that this will be accurate approximately 75% of the time with normal trading and even more so with cryptocurrency trading. The same is true for the market making new lows, just in the other direction.
Momentum is what we use to gauge how to strong the potential is for a possible trade. To identify this we draw a line from the bottom of the nearest low to the top of the nearest high. The more vertical and stretched this line, the greater the momentum. This can be done for the previous lows and highs to determine how the momentum is changing. If it is increasing, then this may be a good signal to consider a trade because we want to enter with increasing momentum. The same method can be applied for trades to the downside except the drawing of the line will just be the other way around.
Candle stick formations are an important tool we use to determine possible entries because they often give us a signal of what the price is going to do. We look for candles that show uncertainty. These are candles with small bodies and long wicks. Simply by looking for these on different charts can help to identify possible cryptocurrencies to trade. Examples of candle formations that you might look for are shown below:
It is best if you can identify these candle formations in an area of structure.
We refer to structure as areas on a price chart where the price has previously made significant moves or has been stuck. The reason for this is that it is likely that it will react again when it reaches these areas. That is why we look for a candle formation in these areas because it is a very strong signal that the price will move in the direction we expect it to.
Putting it all together
We’ve gone into some detail on the fundamentals of trading cryptocurrency successfully. Along with a winning strategy you need a winning mind-set. Ultimately, trading involves your ability to read the markets effectively. It’s only when you can read the markets effectively that you can make the right decisions based on the fundamentals that you have already learnt. Trading involves interpreting an environment that changes constantly…therefore your decisions are only based on the likelihood of something happening rather than certainty. In order to make decisions based on “possibility” rather than “certainty”, you have to prepare your mind psychologically so that you stay away from making decisions that result in excessive loss.