Risk Management in Crypto Trading: Simple Rules to Follow
The rules of the risks attached to cryptocurrency trading don't need to be impossible to follow. In this, we explore risk trading and how...
“I am new to crypto, I see these trading graphs with lines and I read/hear all these buzzwords but have no idea what they mean and/or where to start.”
The first thing you need to know when starting to learn how to trade cryptocurrencies is how to identify individual coins and the different markets that you can trade them on. Websites like Tradingview.com and Investing.com are great places to start, and offer free cryptocurrency charts for you to analyze and get to grips with.
Each cryptocurrency has its own ‘ticker’ or abbreviated symbol that is used to identify it when trading on an exchange or viewing a trading chart. Bitcoin has the ticker ‘BTC’, Ethereum has the ticker ‘ETH’, Litecoin’s ticker is ‘LTC’ and so on. You can find out a cryptocurrency’s ticker simply by searching for it on Coinmarketcap.com or any other coin listing website.
A cryptocurrency’s ticker does not change, it is the same across every exchange and cannot be altered.
When trading on an exchange or analyzing a cryptocurrency’s chart, you are limited to specific fiat and cryptocurrencies that another digital asset can be traded against. A ‘market’ refers to these fundamental currencies.
Bitcoin, Ethereum and USDT (Tether) are the 3 main cryptocurrency markets that you will come across on digital asset exchanges. For those of you who aren’t familiar with Tether, it is essentially a virtual currency version of the US dollar which can traded as digital fiat, where each USDT token is pegged to 1 real USD in order to stabilize its price against crypto market volatility.
This means that if you are planning on buying/ selling or researching a particular coin, you will need to determine which trading pair or ‘market’ you would like to do so in. For example, if you are interested in buying Stellar Lumens (XLM) and you already own Ethereum, you will need to trade on the XLM/ETH market. The same goes for if you are interested in analyzing Stellar Lumen’s price against Ethereum on a trading chart.
When trading on a crypto exchange in particular, a vast majority of platforms tend to exclusively support crypto-crypto trading pairs only. There are some exchanges however, which allow fiat currency trading pairs but these are exclusively limited to major circulating currencies: US dollar (USD), Japanese Yen (JPY), Great British Pound (GBP), Korean Won (KRW) and the Chinese Yuan (CNY). When analysing or trading against a fiat currency pairing, you use each ticker shown above, in exactly the same way as you would against a cryptocurrency.
So now that you understand how to identify and search for particular crypto assets in each market, the next step is grasping the basic fundamentals of a trading chart and what all the data means.
Above is an image of what a typical crypto trading chart looks like.
First off you can tell by the tickers in the top left-hand corner that this is a chart of Bitcoin trading against the US dollar.
Along the bottom of the chart you have the date, on the sides you have the price (which in this case is in dollars) and also a real-time price line which tells you what price BTC is trading at.
The chart itself is composed of ‘candlesticks’ or ‘candles’ which are usually green and red in colour, and are used to represent an asset’s ‘price action’. This simply refers to an asset’s price activity or direction that it takes in the market.
Although they may look very confusing, candles are actually a really simple and effective way of representing an asset’s market movements. Green candles are known as “bullish” candles, that is, when the closing price finishes higher than the opening price. This means that during a certain time period the asset has risen in value. The lines above and below a candle are called “wicks” and they represent the lowest and highest price points that the asset reached during that particular candle.
Red candles are known as “bearish” candles where the closing price finishes below the opening price. This means that the asset has fallen in value. In the example shown above you can see that the red candle has no wick above it. This occurs when an asset does not rise any higher than it’s opening price. The same can happen with wicks below, if the asset does not fall in value below it’s closing/opening price.
Next to the trading pair you have the time period of each candle. Time periods can be adjusted at will to minutes, hours, days, weeks, months and years.
By altering the time period, you increase or decrease the length of trading time that a candle is representing.
This is a useful tool that allows you to view intraday, daily, weekly or monthly charts depending of what type of trading you’re interested in.
For example, if you set the time period to 5 minute candles, you can observe the price action much more closely to watch for sudden deviations – this is great if you’re looking at intraday trading and want to open and close quick positions.
Daily candles therefore are useful for long-term investors who are interested in ‘HODLing’ or trading an asset over a greater length of time.
To summarise this point quickly, depending on what type of trading you are looking to do will determine what sort of candle time range you use. Short-term investors are better off using closer ranged candles, anywhere between 5 minutes to 2 hours. Mid to long-term investors will tend to use anything from 4hr candles onward.
Ok so by now you may have heard a few buzzwords in this guide or during your own research that you may not be familiar with, some of which are common trading terms and others which are uniquely crypto-related. Below is a list of the most frequently used terms that you will undoubtedly come across when trading, analysing and researching cryptocurrencies;
HODL: “Hold On for Dear Life”. This is a hugely popular term in the crypto space adapted from the term “to hold”. The word comically refers to when crypto investors hold on to their crypto portfolio’s during a steep market decline.
FUD: “Fear, Uncertainty, Doubt”. This term is used when mainstream media, individuals or group spread rumours/ news about market shortcomings or predict bearish drops when there may be insufficient evidence to support it. Sometimes these individuals or groups are said to be “spreading FUD” to create a negative response in the market.
Alt-Coins: This term stands for ‘alternative coins’ and can be used to reference any cryptocurrency that was created after Bitcoin. Basically every coin other than Bitcoin is an alt-coin.
Hard/ Soft Forks: Forks occur in blockchain networks for a number of reasons, usually when developers wish to make fundamental changes to the underlying protocols or when an existing blockchain has been corrupted/ breached.
Hard fork: A permanent change which creates an entirely new blockchain, rendering the old chain obsolete.
Soft fork: These are temporary divergences in the blockchain that are used to implement network upgrades and minor modifications. Both the ‘old chain’ and the new chain are still compatible with each other.
SegWit: This stands for ‘Segregated Witness’ and is a protocol upgrade that reduces block sizes by removing signature information. When blockchains like Bitcoin and Litecoin became too ‘heavy’ in the past, they both employed SegWit as a means of reducing their block sizes to help with scalability.
DLT: “Distributed Ledger Technology”. This refers to the decentralised nature of blockchain technology. When anybody synchronises to a blockchain as a ‘node’, they each have a complete record of every transaction ever made over that particular network. This means that the ledger is distributed worldwide and not held exclusively by any single party or organization. Because of this, it is virtually impossible to corrupt a blockchain ledger because you would have to change every single nodes ledger individually.
Decentralized: You will see this term everywhere. Decentralisation refers to the concept that no single entity, organization or nation can control a cryptocurrency because of DLT. It also means that a blockchain network does not possess any single point of failure because it is distributed identically across the world to thousands of people (Generally speaking). Unlike fiat currencies, a vast majority of cryptocurrencies have finite supplies which cannot be manipulated or changed by anyone, even their own creators. Cryptocurrency creators also do not possess the ability to reclaim or freeze coins once they have been released after an ICO onto exchanges.
ICO: This stands for “Initial Coin Offering” as is the crypto equivalent of an IPO in the traditional corporate world. ICO’s are employed by crypto startups to raise initial seed capital to begin developing a service or product. Tokens or coins are sold at wholesale prices before being released on to exchanges. ICO’s have been heavily scrutinized in recent times because of the sheer number of ‘scam ICO’s’ that have been created to swindle money from unsuspecting investors.
Bullish/ Bearish: Our first trading term is perhaps the most widely used term that you will come across. “Bull, Bulls, Bullish” are all part of the same term that is used to identify ‘market buyers’ and indicate a positive moving market. If an asset is surging in price it is regarded as being “bullish”.
Bearish therefore, is the opposite. A bear is a seller/ someone who acts against a market buyer. Bear markets occur when sellers overpower buyers.
Market Sentiment: This term is used to describe the tone of a market. If an asset is gaining well you would say that there is ‘Bullish/ positive market sentiment’. Alternatively if an asset is poorly performing you would say that “Market sentiment is bearish”.
Support/ Resistance: When analysing a trading chart you will begin to notice that there are common price areas where a price returns to/ struggles to break past. This is what is meant by support and resistance (respectively). A support area is a particular price point where an asset ‘rests’ along, usually after a bearish decline. A resistance area is a price which an asset fails to pass above and is often a target for bullish traders when starting a ‘bull run’.
Uptrend/ Downtrend: An uptrend is simply when candles gradually rise on a chart over a particular period of time, usually when there is bullish market sentiment. A downtrend is the opposite of this movement, and is usually caused by a decrease in an asset’s demand.
Reversal: This is a fairly self-explanatory term. A reversal is when an asset finds support after downtrending and begins to travel back upward. This can also be used to describe a sudden bearish decline after an asset reaches a peak price point.
As mentioned before, identifying support and resistance lines are vitally important to every investor when deciding on whether to make a trade or not. Finding these lines will provide you with a strong foundation to analysing an asset in more detail.
Looking again at the BTC/USD chart below over 1 day candles, we can see very clear support and resistance lines that have played an important role in shaping Bitcoin’s price action over the last few months.
The best way to identify a resistance area is by drawing a line connecting all the highest highs of the price action. Sometimes you will find that a line does not always fit perfectly between certain points and you may have to disregard certain anomalous candles, but you will still have a good idea of where the price action is likely to struggle against in the future.
The same goes for finding support lines; draw a line that connects as many lowest low points as you can find. This level is also sometimes referred to as the ‘base support’ and can be great area to open a position on if the asset has rebounded from the same area in the past.
As you can see in the chart above, Bitcoin was able to springboard back off its base support on 3 separate occasions. That makes this a strong base support level. It’s worth noting however, that base supports can fail if bearish opposition overpowers bullish traders; so you cannot always rely on good support lines alone to make accurate market predictions. The same can be said for strong resistance areas also.
There are also occasions where a resistance or support can ‘flip’ and act as the opposite over a given period. Usually these lines dissect through the price action and can sometimes provide clues that a trend is about to reverse.
In the same BTC/USD chart you can see an example of this ‘flipping resistance/support’ level. On this occasion Bitcoin broke through the downtrending resistance level and began using it as a support area instead; going on to later push off this support and begin bullishly reversing.
A famously renowned Italian mathematician named Leonardo Fibonacci discovered a hugely important sequence of numbers back in the early 13th century. The sequence of numbers had a wide range of incredible applications in algebra, geometry and was later used to explain natural phenomenons such as how plants flower and snails shells form.
During the 20th century stock traders began to notice that future support and resistance levels could be identified by using a certain range of numbers from the Fibonacci sequence; particularly 0.236 (or 23.6%), 0.382 (38.2%), 0.5 (50%) and the 0.618 (61.8%).
This trading tool is still very popular, even in today’s highly volatile and often unpredictable crypto market. You can use this indicator tool in a number of different ways to predict all kinds of different patterns, but for now we will focus on its basic application.
When using Fibonacci retracement you will want to identify both a high and low point on the chart over a particular time period that you’re interested in analysing. On the BTC/USD chart above, the high point from early May 2018 was used and measured all the way to the lowest price point at $5,856. Here you can clearly see how the projected Fibonacci support and resistance levels have played important roles throughout Bitcoin’s recovery from the lowest price point, and where Bitcoin is likely to find support and bearish selling pressure in the future.
Now that you have an understanding of support/ resistance areas and Fibonacci retracement, it’s now time to look at 3 of the most commonly used indicators by market traders; MACD, Relative Strength Index (RSI) and Moving Averages.
MACD stands for ‘Moving Average Convergence/ Divergence’. It belongs to a group of indicators known as ‘lagging’ indicators, which means that it plots data after a particular movement has taken place on the chart. Nevertheless, the MACD indicator is every trader’s bread and butter when it comes to measuring an asset’s strength and future direction.
The MACD comprises of two moving averages (MAs), the ‘faster’ MA and the ‘slower’ MA. The former tracks the price action much closer than the latter, which allows us to draw market inferences when the two interact.
When the faster MA converges (or passes above) the slower MA, we assume that buying momentum is gaining behind an asset. When the fast MA diverges (passes below) the slower MA, we assume that selling momentum is gaining.
There is also a horizontal 9-day MA line known as the ‘signal line’ which is used to determine buying and selling signals. When both MA’s pass below the signal line, we assume that overall momentum is dropping and assume it’s gaining when it crosses above. This is accompanied by a histogram that sits along the line to represent a movement’s strength and duration.
In the BTC/USD chart above the MACD is the bottom indicator. Here you can see that both MAs are high above the signal line, with the faster MA pulling away from the slower MA. This is a good signal indication of strong buying moment behind BTC right now.
The RSI indicator is the opposite of the MACD, in that it is part of a group known as ‘leading’ indicators. This means that it users a particular formula to predict price movements ahead of time.
The RSI is an oscillator which travels between zero and 100. Inside this range is an index channel that runs between 30 and 70. When the RSI passes below 30, we assume that the asset is ‘oversold’ – meaning that the asset has is trading below its expected market value and should recover shortly. When the RSI passes above 70 we assume that the asset is ‘overbought’ – this means that the asset is trading above its perceived market value and typically corrects back into the channel soon after exiting.
In the BTC/USD chart above you can see that BTC was already oversold in an earlier market movement and is close to breaking above 70 again. Among other things this tells us that demand for Bitcoin is high and that the asset has strong buying momentum behind it.
There are two types of Moving Averages that most traders tend to use, Simple Moving Averages (SMA or just MA) and Exponential Moving Averages (EMAs).
The only difference between these two is that EMAs give greater weight to the more recent price points whereas the SMA applies the same weight across all price points. In the example above we are using EMAs.
Any moving average can be adjusted to different lengths – a low value (5,10,15 etc) will give you a very close moving average relative to the price action, whereas a higher value MA (50,200,500,1200 etc) will give you a much broader average line. Similar to time periods, moving average lengths can be adjusted to suit whichever type of trading you’re interested in doing/ monitoring. You will always want to use at least 2 moving averages together to give you similar points of reference that you get on the MACD indicator.
If you’re looking at intraday trading Bitcoin, you’ll most likely look at BTC/USD over 5min- 30min candles and use two MA’s or EMAs set at something like 10/25. This means that one MA is tracking an average of 10 candles, while the other is tracking an average of 25. If the lower value converges above the larger value MA, you can assume that the market is moving bullish. Alternatively, if the 25 MA begins to cross through the 10 MA then this will give you a good indication of a bearish market.
If you’re looking at trading daily charts like the one above, then the best combination to use is 50/200 MA or EMAs. When the 50 MA crosses above the 200 MA it is known as a ‘Golden Crossover’ and is widely regarded as a very strong buying signal. If the 200 MA crosses below the 50 MA it is known as a ‘Death Cross’ and indicates strong selling pressure from the bears.
Finally, we have a selection of basic patterns that sometimes form in an asset’s price action, and which tend to foreshadow bullish or bearish market movements before they happen.
It’s worth reiterating at this stage that when you begin analysing the crypto market you will want to combine ALL of these individual factors together before making your prediction/ move.
A general rule with all patterns is that if candles enter into the pattern from the bottom, they are likely to continue upward (bullish). If candles enter into the pattern from the top, they typically continue downward (bearish).
Flag patterns are characterised by having evenly downtrending/ uptrending support and resistance levels. The price action can sometimes travel for a very long way inside these patterns and can be difficult to spot at first.
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