Trading Cryptocurrency: Beginner’s Guide to Understanding & Trading the Currency of the Future
Learn the fundamentals of cryptocurrency and how to make it work for you
There is a lot of stigma surrounding cryptocurrencies with some comparing them to pyramid schemes and the economic bubbles of the past.
Even governments have adopted a cautious approach towards them because of the spooky way in which cryptocurrencies function. Since cryptocurrencies are managed through an advanced encryption technology, the lack of direct control over them makes it difficult for most to accept them as a mainstream method of exchange.
The lack of data also makes people uncomfortable because every decision-making process uses trend prediction which itself relies on historical data.
But this is no different from the fear of unknown. Since the dawn of mankind, we’ve been afraid of things that we don’t understand or are unable to comprehend. In case of cryptocurrency, the lack of information and knowledge prevents people from investing in this currency of the future. This guide is meant to help you understand what cryptocurrency is and what it isn’t.
Then we’ll cover why you should trade cryptocurrency, how it works, and how you can start trading cryptocurrency. We’ll also discuss few crypto trading mistakes that you should avoid when you’re just starting off.
What is Cryptocurrency?
A cryptocurrency is a digital form of money and functions as a token which can be exchanged for services or products.
Cryptocurrencies use an encrypted, decentralized system that allows users to make secure payments and store money. This means the users don’t have to provide their personal details or need to go through a financial institution such as a bank to complete the transaction.
Cryptocurrency isn’t the only form of digital currency. You’ve surely encountered and used some other digital forms of money in the past such as:
- electronic fund transfers using debit cards and credit cards
- mobile digital wallets like Apple Pay or Venmo
- virtual currency which is distributed and controlled by its developers and only accepted inside a community such as Fortnite V-Bucks or Facebook Credits.
Now, you must be thinking:
What makes cryptocurrency different from these?
Electronic fund transfers and mobile digital wallets use a centralized system. When you use them, you’re basically telling a financial institution to add some money (credit) or take out some money (debit) from a person’s account.
On the other hand, cryptocurrencies use decentralized control. The integrity of the system is maintained through a distributed agreement between several parties known as miners and there is no single authority. The miners use their computers to validate each transaction and maintain the balance of ledgers.
Usually, virtual currencies are also centralized. But Ripple and Stellar are examples of decentralized virtual currencies. The way cryptocurrencies differ from all kinds of virtual currencies is through the use of cryptography, from which the term cryptocurrency was coined.
Cryptography is a process of converting legible information into an uncrackable code. Cryptocurrencies use cryptography to secure every transaction and to control the creation of new units. The ownership of newly created cryptocurrency units can be proved exclusively through cryptography and this happens to be one of the six conditions which must be met for a virtual currency to be called a cryptocurrency.
Why Should You Trade Cryptocurrency?
Investing in cryptocurrency involves buying it and holding it for longer periods of time such as a quarter or a couple of years. Trading cryptocurrency means you’re making active transactions over shorter time frames and selling short as well as going long by holding it for a few days or months.
Many retail traders have been outplayed in the legacy market fields because of the amount of competition, the abundance of information, as well as the use of high-frequency algorithms by bigger players. On the other hand, cryptocurrency is relatively new and the field isn’t saturated by institutional investors.
The crypto market is inherently volatile and large swings are commonplace. This scares away amateur investors and provides a great opportunity to seasoned traders.
Cryptocurrencies attract huge short-term speculative trading interest which causes a dramatic fluctuation in their value. Statistically speaking, a large rise in the market is followed by a similar large rise or a fall by the similar amount. This is known as volatility clustering. If the market is showing high volatility today, it is likely to continue showing high volatility tomorrow as well. Big fluctuation in prices allows traders who understand the market to make big profits.
Traders who are just trading cryptocurrency as a hobby are more inclined to make impulsive decisions which create volatility. They emotionally chase the markets and buy high for fear of missing out and sell at a loss by panicking at the market crash. Markets driven by such “dumb money” tend to be more volatile and easier to predict if you know what you’re doing.
How Does Cryptocurrency Work?
Cryptocurrency works with the help of the blockchain technology.
Simply speaking, a blockchain is a distributed database that exists on a network of connected computers with some special instructions on how to maintain, update, and make changes to the database. Here, distributed means the data isn’t stored in a single location or on a single computer. Every computer on the network has this database and anyone can access the data.
Let’s take a smaller example to make it easier for you to understand the blockchain.
Suppose your office computer is connected with every other computer in the office. This is the network. At the start of the year, your boss copied a document containing two columns, one for the account numbers of your clients and one for how much money the accounts have. Such a document is known as a ledger and this is the database.
Now, imagine that this network has been designed in a special way to update the entries each time a transaction takes place between your clients and your business. This is the basics of the blockchain.
How Does Blockchain Help Crypto Transactions?
As there’s a lot of technical stuff going on under the hood, let’s try to understand how cryptocurrency transactions work with the help of a real-world example.
Suppose Tim wants to send money to Eric to pay for his cooking course. He uses something known as a wallet app to accomplish this.
Tim enters the amount he wants to send and Eric’s account number. When Tim hits send, the wallet sends a message to the blockchain network telling how the ledger or the database should be updated: which account should be debited, which account should be credited, and by what amount should the change take place.
What is preventing some sort of thief to use someone else’s account to make a transaction?
Well, every message sent from the wallet must contain a kind of digital signature to prove that it was created by Tim, who is the true account owner, and not by someone else. This is similar to the signature we have to supply on cheques.
Unlike traditional wallets that you carry in your pocket, cryptocurrency wallets don’t store the cryptocurrency. Instead, they store keys that allows the wallets to interact with the decentralized network. Every account number has a key associated with it that only the true account owner knows.
And this is where the cryptography comes into the picture. When it comes to cryptocurrency, the purpose of cryptography is to prove ownership. The function of the key is to generate digital signatures by encrypting transaction messages.
Other individuals on the network then test the digital signature on the transaction message by trying to decrypt it. If they’re successful, they know that the digital signature was indeed generated by Tim. The network then updates the ledger, deducting the amount from Tim’s account and adding the same amount to Eric’s account.
Once verified, the transaction is combined with other transactions to create a new block of data for the ledger. The new block is then added to the existing blockchain. You can now break down blockchain to understand it as a long chain of connected blocks of data.
How to Trade Cryptocurrency?
As we covered in the first section, trading cryptocurrency means you’re making active transactions over shorter time frames and selling short as well as going long by holding it for a few days or months. Now, let’s talk about the ways in which you can actually start doing that.
Essentially, you need to choose a cryptocurrency wallet and a cryptocurrency exchange in order to start trading.
As we mentioned before, unlike traditional wallets, cryptocurrency wallets don’t store cryptocurrency. They store keys that allows the wallets to interact with the cryptocurrency network. Cryptocurrencies usually have an official wallet or they recommend a few third-party wallets that you can consider.
5 types of cryptocurrency wallets
Desktop wallets can be downloaded and installed on a desktop computer or laptop. You can access them only from the same computer that they’re installed on. They do offer a lot of control since you have them with you on your computer but in case your computer comes under an attack from a hacker or gets infected by a virus you might get locked out and lose your funds.
Online wallets are in the cloud and can be accessed from anywhere. Although these are more accessible, you have to be careful with these because clouds are more susceptible to attacks and theft.
Mobile wallets are basically an app on your phone. They provide a greater ease of use than desktop and online wallets because they can be used in retail stores.
Hardware wallets differ from the above-mentioned software wallets in that they store your data on a physical, hardware device such as a USB stick. The transactions are performed online but the storage is completely offline, which improves security. Wallets that allow you to store your currency data offline are called cold wallets while those that keep the currency data somewhere on the internet are called hot wallets.
Paper wallets are either a physical copy of your keys or a software that generates your keys which can be printed out. These are very easy to use and offer a very high level of security.
Things to consider when choosing a cryptocurrency wallet:
- Security: We cannot stress this enough. You should do enough research to make sure that the wallet provider you’re choosing is going to be safe. Some wallets happen to be safer than others. Offline wallets are safer than online wallets because they’re not even connected to the internet all the time. The wallet provider should have a good reputation and provide you options to keep your funds safe. Make sure that the wallet provider allows 2-factor authorization. You should backup your wallet every now and then and keep only a part of your funds available in an online wallet. Keep the wallet software updated so that it has all the latest security features and exploit fixes.
- Anonymity: Every wallet is pseudonymous. So while your name or address won’t be public, your wallet address can be traced and linked to your personal identity in several ways.If you want a higher level of anonymity, you should look at wallets which might be offering this.
- Supported cryptocurrency: Some wallets support only the major cryptocurrencies while others support a wider range. If you’re interested in trading a variety of cryptocurrency, you should be looking at setting up a multi-currency wallet.
- Ease of use: You should pick a wallet that is simple and has a clean, intuitive interface. It shouldn’t require too much effort on your part to set it up. If you think you’ll be using your mobile to access your wallet more frequently, consider getting a mobile wallet that has been designed for this purpose.
Cryptocurrency exchanges are online platforms which allow you to exchange one cryptocurrency for another or a cryptocurrency for fiat currency and vice-versa. You can think of it as a combination of currency exchange and stock exchange.
3 types of cryptocurrency exchanges:
1.Centralized Cryptocurrency Exchanges
These exchanges are similar in their functioning to the stock exchanges. The exchange will act as a middle-man and facilitate the transaction between the buyer and the seller. These are called “centralized” because there is a single authority which is trusted by all the parties, i.e., the exchange itself. As you can imagine, such an exchange is vulnerable to security attacks and if the exchange fails, there is chaos.
2.Decentralized Cryptocurrency Exchanges
In these exchanges, there is no central figure who looks over the transaction. The buyer and seller negotiate and carry out the transaction between them without the involvement of a third-party. This is also known as a peer-to-peer or P2P trade. Currently, decentralized cryptocurrency exchanges are not as popular so there is an issue of low volumes. It also causes the problem of low liquidity – not being able to readily convert the cryptocurrency into cash quickly.
3.Hybrid Cryptocurrency Exchanges
Hybrid exchanges are looking to get the best of both worlds by merging the best features from centralized and decentralized exchanges. These exchanges enjoy the functionality and liquidity of centralized exchanges while employing the privacy and security of decentralized ones.
Things to consider when choosing a cryptocurrency exchange:
- Security and fraud: It’s very important to do your research and choose a secure platform. Ensure that the exchange is wary of the current frauds that are prevalent in the system now and takes measures to secure itself against them. For your own security, go with an exchange that has an option for 2-factor authorization and sends verified, encrypted emails that cannot be read by a third-party.
- Mode of purchase: Cryptocurrency exchanges support different modes of purchase such as bank transfers, PayPal deposits, and credit or debit cards. Some exchanges are limited to certain modes and don’t offer a variety. Few such as Binance only allow cryptocurrency for purchases. If you’re starting to trade, you’ll have to go for an exchange that allows you to purchase cryptocurrency with bank transfers or credit/debit cards.
- Supported cryptocurrency: Most exchanges only support the big players such as Bitcoin and Ethereum. There is a lot of variation in the number of cryptocurrencies that are supported by a given exchange. Make sure you choose an exchange that supports all of the cryptocurrencies that you’ll want to purchase.
- Trading fees: Low transaction fees on trading will allow you to keep most of your margins, especially if you’re looking to become a constant trader. It is important to look at the fee structure of your exchange, to see how much it will cost you as compared to other exchanges. Some exchanges offer discounted fees if you use their own cryptocurrency to complete a transaction. Then there are some that allow you to make purchases freely and only charge you when you’re making a sale.
- Ease of use: Make sure that the user interface of the exchange is easy to understand and clean enough to avoid any confusion. It doesn’t matter if you’re new to cryptocurrency trading or a veteran, an intuitive interface will allow you to make informed decisions and be more efficient overall.
In the end, we’ll recommend that beginner trader should choose a reputable company that offers an exchange as well as a wallet. They should start by trading prominent coins such as Bitcoin or Ethereum.
A Simple Cryptocurrency Trading Strategy
Trading cryptocurrency encompasses a wide range of tactics and strategies depending on the exchange platform and the cryptocurrency itself. How can you start trading once you get your wallet and cryptocurrency exchange in place?
Let’s dive into a simple yet effective cryptocurrency trading strategy that leverages the high volatility of the market to your advantage.
As noted before, the cryptocurrency market is volatile. You can see small dips as well as large dips, known as corrections or crashes.
As the price of the cryptocurrency starts to go down, start buying. Increase the purchase amount as the decline continues. This will allow you to create an average position that will be profitable. This is better than hoping to buy a large amount at the bottom of the dip because predicting the bottom is impossible.
You can then quickly sell for a short profit or hold for a while to build a long-term position.
Now, you can approach this strategy in two ways. In case you don’t want to invest much time and effort in trading, this strategy simply resolves into “buy when the price is lower than the last high”.
However, if you’d like to approach trading cryptocurrency efficiently, this strategy can get a little complex and involve studying cryptocurrency price charts, keeping a close eye on short-term as well as long-term moving averages on different time scales, studying historical data for support levels and so on.
There are a few caveats to keep in mind when using this strategy:
- This strategy works better in a bull market where the trend is “generally increasing” or even stagnant as compared to a bear market where the trend is “generally decreasing”.
- If you follow this strategy, we’d advise you to go with an exchange which allows you to trade quickly and set limit orders.
Tips for Cryptocurrency Trading
In any given cryptocurrency trading campaign there can be a lot of moving parts. It can be difficult to tell which parts of your campaign are working and which need some fine-tuning. What exactly goes into a best-in-class trading system? Here are a few tips when starting out.
Pay Close Attention to Various News Sources
Short-term cryptocurrencies can be sensitive to relevant news of the time. Events such as changes in government regulations or security attacks on the cryptocurrency cause the price to fall. On the other hand, advancements in some break-through technology that might affect the cryptocurrency’s purpose or adoption of the cryptocurrency by some big businesses will cause their price to rise. If you’re already tapping into the noteworthy news sources, you’ll have an edge over the rest of the market.
At the very least, make sure that you’re following the cryptocurrency’s Slack channel or blog. There you can view the interaction of the cryptocurrency’s development team with the community and even ask questions to get more information. Other community forums such as Reddit will also provide you a lot of information as well as expert opinions by the veterans who might’ve been following the cryptocurrency since the start.
Perform Technical Analysis to Stay Ahead
Make sure that you analyze the historical price chart of your cryptocurrency to unearth important patterns that can indicate you where the market is going. There are three types of charts in technical analysis: line chart, bar chart, and candlestick charts.
Of these, the candlestick charts produce apparent signals that can help you navigate through all the complexity of the market. You should strive to identify the patterns that will supplement your own trading style and strategies.
Track the Important Cryptocurrency Metrics
Market capitalization, circulating supply, current trading volume, and the number of wallets vs. number of active wallets, are a few important cryptocurrency metrics that you should always be tracking.
These allow you to assign a value to the cryptocurrency and you can then make informed decisions on the current market price of the cryptocurrency.
Keep Bitcoin in Your Crosshairs
Bitcoin is the very first cryptocurrency, launched in 2009. Since then it has gained too much popularity among the mainstream to be ignored. All the other cryptocurrencies are essentially affected by how the Bitcoin price moves in the market.
If the price of Bitcoin rises by a large margin, people try to sell off other cryptocurrencies in their portfolio to buy Bitcoin. On the other hand, if its price drops by a large margin, people lose faith in cryptocurrencies as a whole and exchange back to fiat. Both of these events cause a fall in the price of other cryptocurrencies.
Categorization of Investments Will Keep You Safe
When you’re doing your research, you’ll come across a number of different categories of cryptocurrencies. Some of them will be sparkling flames which are good for short-term trading while some of them will be sleeping giants that will do well in the long run. Once you get the hang of trading cryptocurrencies, you should diversify and buy some from all the different categories (short-term, medium-term, and long-term) to build your portfolio.
You shouldn’t even touch the medium- and long-term portfolio even when the market is showing a downward trend. This is because you have done due diligence in performing the research, understanding the technology behind the cryptocurrency, real-world use cases, and you trust the development team.
Cryptocurrency Trading Mistakes to Avoid
So…you’ve decided to start trading cryptocurrencies. But why do most beginners find it hard to stay in the game and reap a profit? What are the crypto trading mistakes that you need to avoid at all costs? Let’s go over them one-by-one!
Buying a cryptocurrency solely based on its price
A common mistake that beginners make when diving into the world of cryptocurrency is choosing to trade a cryptocurrency simply because its price is lower and “affordable”. You should always focus on the market capitalization just like traditionally stocks are valued based on the company’s market capitalization performance.
Don’t just look at the price tag of one unit of cryptocurrency; multiply it with the existing units in circulation to get the market cap and evaluate the coin based on that metric instead.
Getting greedy and ignoring your stops
This is a rookie mistake that causes traders to lose in the long-term as it develops into a habit. It doesn’t matter how solid your strategy or technique is, once you start ignoring the stops, the trades turn into investments. And these are usually bad investments.
Taking up trades that don’t meet their strategy
Trading is all about setting up a game plan and sticking to it till you have enough data to make required tweaks. When beginners enter the trading field, they get overwhelmed by opinions and suggestions of the gurus and start making trades which don’t even meet their trading criteria. The fear of missing out is to blame here.
Keep in mind that the cryptocurrency market is quite volatile and you’ll get some cases where going out of your strategy might be beneficial. But it’s not in your best interest to take those trades if you’re in for the long game.
Sticking with a losing trade because it “owes you”
When you’re invested in a trade and it doesn’t provide you the desired profits, it is simply better to call it quits and go for something else. If a cryptocurrency has caused you to lose for a while, it doesn’t mean that it will eventually average out or even swing in the opposite direction. This is known as gambler’s fallacy.
Investing more than you can lose
When it comes to cryptocurrency, there is no guarantee whatsoever that you’ll get back the investment that you’ve made, let alone make a profit over it. There is no way to predict how the market will move and losses can come from changes in government regulations, security attacks, technical bugs, or simply from erosion of investor confidence.
If you’re investing money that you can’t lose, you’re setting yourself up for failure because trading will stress you out every day and force you to make emotion-driven trades. This also makes you susceptible to all the other mistakes that we’ve discussed above.
There you have it, folks. Now that you know more about how to trade cryptocurrency, we recommend you try downloading this eBook and start doing your research on which cryptocurrency you’d like to start with.
The basics we’ve gone over in this guide are just the beginning. Keep following news on cryptocurrencies, understand how to do technical analysis, and take help from experienced traders if you feel stuck. Last but not least, never stop learning. The more you tweak and test every step of your cryptocurrency trading process, the more you’ll improve your trading portfolio and reap profits.