Before even thinking about venturing into cryptocurrency trading, it is important that one has a comprehensive understanding of the assets and technologies involved.
Bitcoin (BTC) is the soil from which thousands of other cryptocurrencies have grown. So, it is helpful to first understand the foundational asset upon which the crypto industry emerged. For a thorough introduction to Bitcoin, read ASA’s “What is Bitcoin?” guide.
If you are interested in pursuing this highly speculative and risky approach to accumulating value in the crypto economy, the following guide presents the absolute fundamentals of cryptocurrency trading to help chart this unfamiliar territory, covering the components of a trade, the styles of trading, and the role of technical and fundamental analysis in creating a comprehensive trading strategy.
As with stocks and other financial markets, trading cryptocurrency can be complex, involving a variety of components and requiring knowledge. Bitcoin launched in 2009 as the first crypto asset and remains the largest cryptocurrency in terms of market capitalization and prevalence. Over the years, however, an entire industry of other digital assets has come into existence, with the assets being tradable for profit. All other cryptocurrencies that are not BTC are known as altcoins, the largest of which is Ether (ETH).
Many different approaches exist in terms of how to trade cryptocurrencies. In order to start trading cryptocurrencies, one first needs adequate knowledge of the subject. It is also critical to know the associated risks and the laws that may apply based on one’s region, and decisions should be made accordingly.
Please note: The following is simply a basic guide for the novice to better understand how trading works and is not intended to be a step-by-step guide promising profitability. Trading is, and always will be, a risky endeavor in any market. Always do your own research before interacting or transacting with any asset, technology, business or individual.
Bitcoin’s value is determined second-by-second, day-by-day by a market that never sleeps. As an autonomous digital asset whose value is determined by an open market, Bitcoin presents unique challenges around volatility that most currencies do not face. Thus, it is important for newcomers to have some literacy of how crypto-asset markets work so that they can safely navigate the markets, even intermittently, and get the most value out of their participation in the crypto economy.
Bitcoin trading can range in scale and complexity from a simple transaction, such as cashing out to a fiat currency like the U.S. dollar, to using a variety of trading pairs to profitably ride the market in order to grow one’s investment portfolio. Of course, as a trade increases in size and complexity, so does a trader’s risk exposure.
First, let’s go over some basic concepts.
A trade consists of a buyer and a seller. Since there are two opposing sides to a trade — a purchase and a sale — someone is bound to gain more than the other. Hence, trading is inherently a zero-sum game: There is a winner, and there is a loser. Having a basic understanding of how the cryptocurrency markets operate can help minimize potential loss and optimize for potential gain.
When a price is agreed upon between a buyer and seller, the trade is executed (via an exchange) and the market valuation for the asset is set. For the most part, buyers tend to set orders at a lower price than sellers. This creates the two sides of an order book.
When there are more buy orders than sell orders, the price usually goes up, as there’s more demand for the asset. Conversely, when more people are selling than buying, the price goes down. In many exchange interfaces, buys and sales are represented in different colors. This is to give the trader a quick indication of the state of the market at a given moment.
You may have heard the common adage in trading: “Buy low, sell high.” This saying can be difficult to navigate in that high and low prices can be relative, although the adage does give a basic representation of the incentives of buyers and sellers in a marketplace.
Simply put, if you want to purchase something, you want to spend the least amount possible. If you want to sell something, you want to make as much out of the deal as possible. While this is generally good wisdom to follow, there is also the added dimension of longing an asset vs. shorting an asset.
To go long on an asset (longing) means buying an asset and earning profit based on its upward price movement. In contrast, going short on an asset (shorting) essentially means selling an asset with the intention of buying it back when its price falls below the point at which you sold it, profiting from a price drop. Shorting, however, is slightly more complicated than this brief description and involves selling borrowed assets that are paid back later.
To the layperson, “the market” may seem like some complex system that only a specialist could ever hope to understand, but the truth is that it all comes down to people buying and selling. The totality of active buy and sell orders is a snapshot of a market at a given moment. Reading the market is the ongoing process of spotting patterns, or trends, over time, which the trader can choose to act upon. Overall, there are two market trends: bullish and bearish.
A “bullish” market, or bull market, occurs when the price action appears to steadily increase. These upward price movements are also known as “pumps,” as the influx of buyers increases the prices. A “bearish” market, or bear market, occurs when the price action appears to steadily decrease. These downward price movements are also known as “dumps,” as the mass sell-offs result in the price going lower.
Bullish and bearish trends can also exist within other larger opposing trends, depending on the time horizon at which you look. For example, a small bearish trend may occur within a broader long-term bullish trend. In general, an uptrend results in price action making higher highs and higher lows. A downtrend makes lower highs and lower lows.
Another market state called “consolidation” occurs when the price trades sideways or within a range. Typically, consolidation phases are easier to spot on higher time frames (daily charts or weekly charts), and they occur when an asset is cooling off after a sharp upward or downward trend. Consolidation also takes place ahead of trend reversals, or in times when demand is muted and trading volumes are low. Prices essentially trade within a range during this market state.
Technical analysis (TA) is a method of analyzing past market data, primarily price and volume, in order to forecast price action. While there are a wide variety of TA indicators, ranging in complexity, that a trader could use to analyze the market, here are some basic macro- and micro-level tools.
Just as traders can spot patterns within hours, days and months, they can also find patterns over years of fluctuating price action. There is a fundamental structure to the market that makes it susceptible to certain behaviors.
The cycle can be partitioned into four main parts: accumulation, markup, distribution and decline. As the market moves between these phases, traders will continuously adapt their positions by consolidating, retracing or correcting as they deem necessary.
The bull and the bear are very different creatures and behave in opposition to one another within shared environmental conditions. It is critical that a trader know not only under which role they fall but also which one is currently dominating the market.
Technical analysis is necessary not only to position oneself within this ever-changing market but also to actively navigate the ebbs and flows as they occur.
Price movements are largely driven by “whales” — individuals or groups who have large funds with which to trade. Some whales operate as “market makers,” setting bids and asks on both sides of the market in order to create liquidity for an asset while turning a profit in the process. Whales are present in virtually any market, from stocks and commodities to cryptocurrencies.
A trading strategy must be aware of the tools of the trade favored by whales, such as their preferred TA indicators. Simply put, whales tend to know what they’re doing. By anticipating the intentions of whales, a trader can work in concert with these expert movers to turn a profit with their own strategy.
With a zoo full of metaphors, it can be easy to forget that real people — for the most part — are behind these trades and, as such, are subject to emotional behaviors that can significantly affect the market.
This aspect of the market is represented in the classic chart “Psychology of a Market Cycle”:
While the bull/bear framework is useful, the psychological cycle depicted above provides a more detailed spectrum of market sentiment. While one of the first rules of trading is to leave emotion at the door, the power of group mentality tends to take hold. The rally from hope to euphoria is driven by FOMO — the fear of missing out — from those who haven’t positioned themselves yet in the market.
Navigating the valley between euphoria and complacency is crucial to timing an exit before the bears take hold and people panic sell. Here, it is important to factor in high-volume price action, which can indicate the general momentum of the market. The “buy low” philosophy is quite apparent given that the best time to accumulate within the market cycle is during the depression following a drastic drop-off in price. The greater the risk, the greater the reward.
The challenge faced by the serious trader is to not let emotion dictate their trading strategy amid the deluge of hot takes and analysis by the media, chat rooms or so-called thought leaders. These markets are highly subject to manipulation by whales and those that can affect the pulse of the market. Do your homework, and be decisive in your actions.
Being able to detect patterns and cycles in the market is crucial for having clarity from the macro perspective. Knowing where you are positioned in relation to the whole is paramount. You want to be the experienced surfer who knows when the perfect wave is about to arrive instead of paddling listlessly in the waters hoping for something great to happen.
But the micro perspective is also crucial in determining your actual strategy. While there are a vast number of TA indicators, we will only go over the most basic.
Perhaps two of the most widely used TA indicators, the terms “support” and “resistance” relate to price barriers that tend to form in the market, preventing the price action from going too far in a certain direction.
The support is the price level where the downward trend tends to pause due to an influx of demand. When prices decrease, traders tend to buy low, creating a support line. Conversely, the resistance is the price level where the upward trend tends to pause due to a sell-off.
Many traders use support and resistance levels to bet on the direction of the price, adapting on the fly as the price level breaks through either its upper or lower bounds. Once traders identify the floor and ceiling, this provides a zone of activity in which traders can enter or exit positions. Buying at the floor and selling at the ceiling is the usual standard operating procedure.
If the price surpasses these barriers in either direction, it gives an indication of the market’s overall sentiment. This is an ongoing process, as new support and resistance levels tend to form when the trend breaks through.
While the static support and resistance barriers shown above are common tools used by traders, price action tends to trend higher or lower, with barriers shifting over time. A sequence of support and resistance levels can indicate a larger trend in the market, represented by a trendline.
When the market is trending upward, resistance levels begin to form, price action slows and the price is pulled back to the trendline. Traders pay close attention to the support levels of an ascending trendline, as they indicate an area that helps prevent the price from dropping substantially lower. Likewise, in a downward trending market, traders will keep an eye on the sequence of declining peaks to connect them together into a trendline.
The core element is the history of the market. The strength of any support or resistance levels and their resulting trendlines increases as they reoccur over time. Hence, traders will record these barriers to inform their ongoing trading strategy.
One influence on support/resistance levels is the fixation on round-number price levels by inexperienced or institutional investors. When a large number of trades center around a nice round number — such as generally occurs with Bitcoin each time its price approaches a figure that is evenly divisible by ,000, for example — it can be difficult for the price to surpass this point, creating a resistance.
This frequent occurrence is a testament to the fact that human traders are easily influenced by their emotions and tend to resort to shortcuts. Certainly with Bitcoin, if a certain price point is reached, it tends to produce an enthusiastic burst of market action and anticipation.
With a market history of support/resistance levels and the resulting downward/upward trendlines, traders often smooth out this data to create a single visual line representation called the “moving average.”
The moving average nicely traces the bottom support levels of an upward trend along with the peaks of resistance throughout a downward trend. When analyzed with respect to trading volume, the moving average provides a useful indicator of short-term momentum.
There are various ways to chart the market and find patterns within it. One of the most common visual representations of market price action is the “candlestick.” These candlestick patterns present a sort of visual language for traders to anticipate possible trends.
Candlestick charts originated in Japan in the 1700s as a method of assessing the way that traders’ emotions act as a strong influence on price action, beyond simple supply-and-demand economics. This visualization of the market is one of the most favored by traders since it can encapsulate more information than the simpler line or bar charts. A candlestick chart features four price points: open, close, high and low.
They are called candlesticks because of their rectangular shape and the lines above and/or below that resemble a wick. The wide portion of the candle is where the price either opened or closed, depending on its color. The wicks represent the price range in which an asset traded during that set period of the candlestick. Candlesticks can encapsulate different timespans, from one minute to one day and beyond, and show different patterns depending on the timeline chosen.
So, how do we determine the potential of a particular crypto asset beyond or preceding its behavior in the market?
Whereas technical analysis involves studying market data in order to determine one’s trading strategy, fundamental analysis is the study of the underlying industry, technology or assets that comprise a particular market. In the case of cryptocurrencies, a trading portfolio will likely consist of Bitcoin and altcoins.
How does one determine if an asset is based on sound fundamentals rather than hype, exaggerated technology, or worse — nothing at all? For fundamental analysis of new assets, several factors should be considered:
Before investing in an asset, it is imperative to assess the integrity and capability of the builders behind it. What is their track record? What software ventures have they brought to market in the past? How active are they in developing the underlying protocol of the token? Since many projects are open-source, it is possible to directly see this activity through collaborative code repository platforms like GitHub.
Community is critical to cryptocurrency projects. The combination of users, tokenholders and enthusiasts generates much of the driving force of these assets and their underlying technologies. After all, there is always a social element to any new technology. However, since there is a lot of money at stake — and with the frequent presence of non-professional retail investors — the space is often subject to toxicity and warring factions. Hence, a healthy, transparent discourse within the community is welcome.
Not to be confused with market technical analysis, the core technical specifications for a crypto asset include the network’s choice of algorithm (how it maintains security, uptime and consensus) and issuance/emission features like block times, the maximum token supply and the distribution plan. By diligently assessing the protocol stack of a cryptocurrency network along with the monetary policy enforced by the protocol, a trader can determine if such features support a potential investment.
While Bitcoin’s intended use case upon its launch was electronic money, developers and entrepreneurs have not only discovered new use cases for the Bitcoin blockchain but have also designed entirely new protocols to accommodate a wider range of applications.
Liquidity (and whales)
Liquidity is critical for a healthy market. Are there reputable exchanges that support a particular crypto asset? If so, what trading pairs exist? Is there a healthy trading/transaction volume? Are large stakeholders present in the market, and if so, what is the impact of their trading patterns?
However, generating liquidity takes time, as a new innovative protocol may be live but may not have instant access to liquidity. Such investments are risky. If volumes are low and there are little to no trading pairs available, you are essentially betting that a healthy market will eventually form around the project.
Branding and marketing
Most cryptocurrency networks do not have a central figure or company facilitating the branding and marketing around their technology, resulting in branding that may lack a cohesive plan or direction.
This is not to discount the branding and marketing that does emerge from a protocol over time; in fact, a comparative analysis of the marketing efforts of core developers, corporations, foundations and community members can provide a detailed overview of how certain players communicate value propositions to the masses.
This quality can be seen as the manifestation of a project’s technical specifications. Despite what is written in white papers or presented at conferences, what is the actual physical manifestation of the protocol in question?
It’s worth mapping out the stakeholders: the developers, block validators, merchants/companies and users. Additionally, it is crucial to understand who the stewards of the network are, their role in securing the network (mining, validation), and how power is distributed among these stakeholders.
Given that all cryptocurrencies operate on blockchain technology at a base level, a new type of analysis (on-chain) that relies on data from blockchains has emerged.
By looking at supply and demand trends, transaction frequency, transaction costs and the rate at which investors are holding and selling a cryptocurrency, analysts are able to make precise qualitative and quantitative observations about the strength of a cryptocurrency’s blockchain network, and it’s price dynamics in a variety of markets.
On-chain data also provides valuable insight into investor psychology because analysts are able to align various macro and microeconomic events with the actions of investors which are immutably recorded on the blockchain.
Analysts look for patterns and anomalies in buying, selling and holding behavior in correlation to market rallies, sell-offs, regulatory events and other network-oriented events to make forecasts of potential future price movements and investor reactions to upcoming events like network upgrades, coin supply halvings and actions taking place in traditional financial markets.
Risk management is also a significant aspect of trading. Prior to entering a trade, it is important to know how much you are willing to lose on that trade if it goes against you. This can be based on a number of factors, such as your trading capital. For example, a person might wish to only risk losing 1% of their overall trading capital either in total or per trade.
Trading is simply a risky endeavor in and of itself. It’s almost impossible to predict any future market activity with certainty. At the end of the day, it’s important to make your own decisions, using available information and your own judgement, as well as to make sure you are properly educated.
Additionally, trading strategies can vastly differ from person to person, based on preferences, personalities, trading capital, risk tolerance, etc. Trading comes with significant responsibility. Anyone looking into trading must evaluate their own personal situation before deciding to trade.