What is cryptocurrency trading?
For people new to the community, the number one question is ‘how to trade cryptocurrency’.
This isn’t a surprise, especially as the volatile nature of cryptocurrency – the rapid increases and decreases in price – creates a lot of opportunity for the trader. However, we must remember that while volatility can create opportunity for profit, it also creates the risk of loss.
The long-term potential of cryptocurrency is hard to assess, given it remains a relatively new phenomenon in finance. Early adopters have seen massive returns and while it is becoming more widely used, the opportunity for significant profit still remains.
The fact it is new, and broadly based around an ethos of decentralisation, means governments around the world question its legitimacy. That creates risk, as well as the possible potential opportunities could be curtailed in future by regulation.
To explain how you measure volatility, we will use bitcoin (BTC) as an example. Basically, look at how the average price from the start of the day has varied and apply a calculation. For instance, take 10 measurements from the day to give you a sum of price variation, square that and then divide by 10 (the original number of measurements). The volatility measure of that day is the square root of your result.
To extrapolate over a fixed period, you multiply that result by the square root of the number of days (ie, for a year, multiply your volatility measure by the square root of 365).
Trading vs Investing
Your challenge is to manage the risks posed by trading in cryptocurrency and make money – by which we mean selling a cryptocurrency asset for more than you paid for it.
Start with two basic questions: will the asset price go up or down in the next day, and will it go up or down over the next four years?
These questions require you predict the price movements, which are, of course, uncertain, but there is a big difference in time frame, which should make you think about the investment, and risk, differently.
What makes a difference in the next 24 hours will not necessarily be the same as what influences the longer-term price trend. You cannot really make a long-term prediction based on one day’s results.
Buying and selling over short periods is trading. Buying an asset and "holding" it for a longer period before selling for profit is called investing, or hodling.
To make money from cryptocurrency, you need to understand the strategy for each. You don’t have to fit into one category or the other – you can both trade and invest, as long as you understand how the decision making differs between the two.
Analysing short-term asset price movement and volume of trading is known as Technical Analysis. When you take a broader look at potential influences, especially on the longer-term value, it is known as Fundamental Analysis.
They can overlap, but are a good framework to separate trading from investing, although both ultimately come down to measuring risk.
You should aim to sell your cryptocurrency asset for more than you bought it for, whether you are trading or hodling. This is where a structured approach and skill-based decision can help manage risk.
If you are trading best on instinct or a random social media post, your fortunes rest with luck. The best traders have a strategy based on analysis and have spent a long time learning. You need clear objectives founded on knowledge and mathematical discipline.
You can learn by doing, so keep a record of your trades and how they went. This is the experience which can help make you a better trader or investor. Start with a realistic goal, be honest with yourself and learn from your mistakes and your victories.
Also be honest that sometimes, despite all your learning and preparation, an outcome can be down to luck. One good result you were not expecting doesn’t mean you have suddenly become a great trader. It’s important to recognise that.