Steemit Crypto Academy Contest / S7W3 - Understanding Crypto Trading

My understanding of cryptocurrency trading and explanation of the term trading

Trading is a term which could be said to be the exchange of goods and services either for money or consideration. This term is all encompassing and is used in all facets of life but if we channel this term and isolate it to apply to the financial markets, we can explain the term “trading” as an activity which could be carried out by individuals and institutions such as band and hedge funds alike involving the sale and purchase of securities such as derivatives, stocks and bonds. !

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Cryptocurrency trading on the other is a term which has grown explosively in recent times. Taking the explanation of the term “trading” as related to the financial markets above. We can explain cryptocurrency trading as an activity carried out on online platforms involving the sale and purchase of virtual currencies which are said to have secure ends through the application of cryptography. Some of the popular cryptocurrencies traded in this market are the likes of bitcoin, Ethereum, Litecoin etc. The trading of such currencies are highly speculative as they have a highly volatile price nature, not to include the highly decentralized nature of numerous currencies coupled with their lack of regulation, there are couple of risks involved as well as reward.

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Trading principles to keep in mind as a crypto trader as well as how to build a trading strategy

When speaking about effectiveness in cryptocurrency trading. We should examine three core areas namely;

Analysis of market
Risk management
Trading psychology

From the top, examining market analysis.

Analysis of market

This principle is essential for success in trading. It encompasses all forms of analytic knowledge including technical, fundamental and sentimental analysis. This would enable traders made informed decisions whether to buy or sell as technical analysis helps to determine price action pattern and trends.

Also, the fundamental part of analysis can’t be ignored. This is one part that most traders tend to pay less attention to and thus they suffer for it.

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Fundamental analysis makes use of economic factors to analyze factors that tend to drive up price. It also helps to know moments of important news release that could have a large impact on price.

Risk Management

This principle is very essential for traders. It goes to show that no matter how profitable your strategy is, if you have a shitty risk management, chances are you’ll end up with losses more often that not. As cryptocurrency trading is considered high risk, it’s important to make use of risk management strategies such as making use of stop-losses, diversifying portfolio and managing leveraged adequately(if you get too greedy with leverage, you may wipe out your account before you can say “wipe out”)

Trade psychology

This is the third but not the least essential principle. Trade psychology follows the ability of a trader to make impulsive decisions in the market, it involves how traders respond to and manage losses as well as how they stick to their trade strategy once developed. The art of discipline is one every trader would be forced to learn in the long run, therefore it’s essential to do that early to gain an head start in the trading race. There are a couple of books to help on this, I recommend “ The psychology of trading by Brett N. Steenbarger to begin with.

building a trading strategy

In building up one’s trading strategy. Its important to know that the fact that someone’s strategy is very profitable doesn’t mean it’ll be the same for you. A trading strategy should be tailored to ones personal effect, account size, risk tolerance, realistic expectations, market conditions etc. One way to do this is to come up with a trading plan that takes into consideration entry and exit points relative to position sizing. Risk management techniques should also be fully employed as risk management could be said to be the backbone of profitability.

Once the framework of a strategy has been developed, it can always be tested and re-adjusted to improve its effectiveness. No one says you should be overly rigid

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Also, it’s important to understand this and let it sink in

no One strategy can guarantee success always, 100%

The sooner traders understand this the faster they’d be able to develop their own personalized plan.

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How to use fundamental analysis to generate trading ideas

In using fundamental analysis to generate trading ideas. The research and analysis of the technology behind a particular cryptocurrency comes into play. In doing this, emphasis should be placed on the underlying blockchain technology of such currency. A stronger technology would always outperform weaker ones and lead to more adoption and usage, which increases the likelihood of such currency increasing in value

Also, it’s pertinent to pay attention to the kind of problem it tackles(scalability, processing speed etc) and the team behind the development. The team plays an important factor as a currency with a strong team is more probable to have a long term standing in the market and yield profitable returns.

To carry out such analysis, we can make use of platforms like Santiment

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Finally, in the use of fundamental analysis to generate trade ideas, the overall state of the market as well as the regulatory environment surrounding the cryptocurrency in questions should be analyzed. Attention should be paid to factors such as the market capitalization, trading volumes, volatility and overall market trend.

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How to use technical analysis when trading on crypto

Technical analysis makes use of historical data to evaluation price action. Therefore by the analysis of historical price data and trends, it can help to generate ideas useful in trading.

The use of concepts such as support and resistance which forms the basis of technical analysis levels which are levels which price had a hard time breaking through such as that shown below. They are potential buying and selling points in the market

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coupled with trend such as bullish and bearish trends in the market as well as technical indicators which forms the mathematical part.

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Not that kind of maths 😂(not far off though)
Technical indicators helps to identify momentum, reversals points as well as trends in the market through mathematical based price calculations. Some commonly used indicators include Relative Strength index(RSI) which helps to determine overbought and oversold conditions in the market.

Bollinger bands as well as moving averages which helps to smooth out price volatility and identify trends.

The conjunction of the two kinds of analysis, fundamental and technical with some other like sentimental analysis could be very valuable to the development of effective trading ideas. It’s advisable to not use just one wholly but incorporate different types of market analysis to provide better trading results.

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Three concepts of risk management every new trader should know

These are important concepts of risk management I believe should be known to beginner traders. They include :

1% rule

The one percent rule, also known as the 1% rule, is a popular risk management strategy used by many traders. This strategy requires traders to never risk more than 1% of their trading capital in a single trade. Although this rule was eventually modified to limit the risk to no more than 2-3%, the underlying ideology remains unchanged

With the potential to increase profits over time, this method helps to minimize risks. Large investors or traders for prop firms frequently employ this tactic..

An illustration of the 1% rule when trading is given below
Considering a hypothetical situation involving two traders with a trading capital of $3000 in their accounts respectively.

Illustration A
Trader A, having an account worth $3000 employs and utilizes the 1% rule effectively and risks 2% for each trade. A total of seven trades were taken for the entire trading month of which four trades were won and three were lost.

Initial portfolio balance - $3000

Balance after fourlosses - (2%) - $60 × 4

Balance after 4 losses (2%) - $2,760

Balance after 3 Wins (2%) - $2,940

The portfolio of investor A after a total of seven trades which resulted in four losses and 3 wins for the month is 2940

Illustration b
Trader B having an account also worth $3000, doesn't adopt the 1% rule and in a bid to make more profits risks 10% per trade. A total of seven trades were taken for the entire month of which four trades were won and three were lost.

Initial portfolio balance - $3000

Balance after four losses - (10%) - $300 x 4

Balance after 4 losses (10%) - $1800

Balance after 3 Wins (10%) - $2,700

The aforementioned scenarios show that investor A has been able to keep more of his trading capital than investor B.

However This estimate assumed that they both maintained a 1:1 risk-to-reward ratio; however, a more thorough analysis combining the 1% rule and risk: reward ratio is provided below.

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Risk to Reward ratio

A good risk to reward ratio guarantees that an investor can earn twice as much as he is willing to risk in the event of a successful trade. This is another crucial aspect of risk management. Since the profit objective will be twice the stop loss target, the minimum risk to reward ratio should be adequate to ensure that the risk is guaranteed to be doubled (1:2).

The adoption of the 1:3 risk-reward ratio, which allows a trader to potentially gain three times what is being risked on a position, is a widespread practice. Trading with a risk-reward ratio of 1:1 or less is not recommended because it will cause an account to have negative balances in the long run.

An illustration of the risk to reward ratio is given below:
If an investor decides to use a risk-reward ratio of 1:3 on a $3000 trading account for every trade and takes a total of seven trades in the month which resulted in four losses and three wins.
The breakdown is given below.

Initial Balance -$3,000

Balance after 4 Losses (2%) using 1:3 RR - $60 × 4

Balance after 4 Losses (2%) using 1:3 RR - $2,760

Balance after 3 Wins (2%) using 1:3 RR - $60 × 3 for 1 position

Balance after 3 Wins (2%) using 1:3 RR - $180 × 3

Balance after 3 Wins (2%) using 1:3 RR - $3,300

We observe that despite having a lower win ratio, we were still left with a positive balance however using a risk-reward ratio of 1:1, in this case, would leave a negative balance as shown above.

c- Stoploss and Take-profit
These risk management strategies are ways to exit an open position in the market. They help traders execute exit trade orders either in a profit or loss.

A stop-loss is a price point or level at which a trader would choose to exit a trade and take the loss if it became unprofitable and invalidated the trade setup. This assists traders in avoiding additional losses on their accounts and minimizing drawdowns.
Take profit is the price at which a trader would choose to automatically exit a profitable trade. This is done at a point where additional profit growth may result in risks, such as when the price approaches a key support or resistance level. The tale profit level is set in a higher ratio than the stop-loss level for a good trade.

These tools are very important to traders as it allows traders to take a break from the markets, whenever a trade has been set and the take profit and stop loss levels have been set, the order would be exited immediately the price approaches any of these levels and the profits or loss would be booked immediately.

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WHO IS DOPPLEY

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