Trading with cryptos is enjoying new popularity in late 2020. Cryptocurrencies have established themselves as unique asset class in their own right. Its dynamic nature and volatility attract interested beginners to trading. Every beginning is hard. Before you start with trading cryptos, there are a number of things, factors and concepts you need to know. In this multi-part series, we will cover everything you need to know before you start trading with cryptocurrencies.
Three Fundamental Ingredients: You, Technical Understanding and Trading Basics
In order to trade crypto successfully, you need to have clarity of and competence in three areas: yourself and your trading goals, a basic understanding of how cryptocurrencies work and the craft of trading.
In our multi-part-series on the foundations of crypto-trading, we are going to cover all of these in great detail. Today, in part 1, we are going to start with you, your goals and objectives.
Trading vs. Investing – Important Key Differences
Firstly, we need to distinguish between trading and investing. While both traders and investors are out to make money, they differ in their time horizon, risk appetite and style of research.
Trading describes the buying and selling of assets within a short time frame – even within days or hours. Traders enter and exit out of trades quickly, at times multiple trades simultaneously. Traders typically have a high-risk appetite. They may also engage in “short-selling” of assets to profit from a potential decline in the asset’s price. Typically, traders have little specific interest in the asset that they trade with and mainly use technical analysis as their decision criteria.
Investing describes the purchase of assets with the intention of participating in a projected long-term growth in the value of the asset. Investors have a medium to long-term orientation and typically invest for 1-5 years or even longer. Investors have low to medium risk appetite and primarily use fundamental analysis to deeply research assets before they invest.
First Things First: Clarify Your Trading Goals and Style
“It all starts with you,” – this is a fundamental truth of trading and investing. Any successful trader has a high level of self-awareness and understanding. To get there, we invite you to engage in a little introspection and ask yourself the following questions:
Why do you want to trade crypto-currencies?
Yes, of course you want to make profits. This can be reason enough, but it helps to have some more reason. Are you interested in the evolving field of digital currencies? Or are you just afraid of missing out on high profits? Do you just want to invest because your friends have been investing? Make sure you understand your own motivation and are guided by it.
How much time do you want to invest?
Trading cryptos takes preparation and ongoing monitoring of your positions. Ask yourself generally, how much time you can and want to invest in these activities. Depending on your time budget, particular trading styles will suit you better than others. Don’t worry, we will discuss trading styles in a later section.
How much money can I put at risk?
Your trading decisions should always be guided by your financial goals and situation. Determine how much money you can and want to put into cryptocurrencies and never go beyond that. A larger part of your investments should be diversified in low risk assets like bonds or blue-chip stocks.
How high is my risk tolerance?
Cryptos are very volatile - offering great trading opportunities but also involving large risks. Your risk tolerance describes how much financial risk you can comfortably live with. Will you weather temporary price declines, or will you impulsively panic sell? How well do you sleep knowing your investments are down safe 30 or 40%? A general rule of thumb for beginners is: your risk tolerance is lower than you think - but it does increase with time and trading experience.
How does crypto trading fit into my overall investment strategy and portfolio?
Cryptocurrencies should never be the first or biggest part of your investment portfolio, they should only be a complement to an existing bigger and well-diversified investment portfolio consisting e.g. of low-volatility assets like bonds and index funds. Investment portfolios usually consist of a combination of low-and high-risk investments, where cryptos with their high volatility increase the overall risk of the portfolio while also increasing the profit potential.”
Clarify for yourself how trading with cryptos fits into your overall investment strategy. Some investors see coins like Bitcoin as a hedge against negative price developments on the stock market or other financial markets, yet recently the correlation between Bitcoin and stocks has been increasing.
Understanding Trading Psychology is Key to Successful Trading
Many successful investors and traders agree, that making money in the markets is primarily a matter of psychology. As a trader you need to manage your emotions, making sure that you let neither greed nor fear dominate your decision-making.
The three most important rules for mastering your trading psychology are:
1. Resist FOMO and PANIC SELLING.
FOMO – the fear of missing out – can be triggered when asset prices increase dramatically within a short period of time. Panic selling may ensue when strong price declines occur within a short time frame. Both are detrimental to your financial success – why?
If you jump on board when prices are already too high and assets overvalued, you may end up losing a lot of money when prices inevitably decline. On the other hand, if you sell in the fear of prices falling even lower…wait! You only realize losses when you sell, yet prices may rise again soon.
When you feel these powerful emotions getting a grip on you, take a deep breath, switch off the computer and get some fresh air. Find your inner center and realize that probably the best thing to do now is to wait for a calmer sea on the financial markets.
2. Set rules with which you trade.
The best way to resist the power of fear and greed is to have clear rules in place for when you buy and sell. Depending on your risk appetite, it is recommended that you establish a level of gains/losses at which you are going to exit each trade.
Moreover, you may determine a fixed amount of money you are willing to lose or make in a single trading session. Once that happens, you exit the trades and take a break to find your calm and center.
3. Realize that losses are part of trading.
Yes, this doesn’t sound very encouraging, does it? Yet the truth is: even the most successful traders incur losses a lot of the times. You can’t be right on every trade. Therefore, when you have one or more losing trades in a row, it is important to realize that this is part of trading.
Don’t beat yourself up about it. Better to take some notes and reflect what could have done differently or what to do better next time. A calm mind is the biggest asset when it comes to trading – your decision should always be guided by reason and logic.
Ultimately, it takes both awareness and experience to master the trading psychology. Being aware of the powerful effect greed and fear may have on your trading decisions is essential to resist the temptation of buying or selling at the worst possible time.
Conclusion: Clarify your goals and objectives before going any further!
Before you start trading, it is essential that you develop an inner sense of clarity on your trading goals and style. Answering the questions provided will help you in doing so.
Moreover, you need to be aware of the importance of trading psychology – managing your attitude and mindset is key to successful trading. Don’t let fear and greed get the best of you – take a time-out, get some fresh air and only trade when you are centred in self and reason.
Have you achieved a certain degree of clarity? Great. In the coming part 2 of our series on Trading 101, we will take a deep dive into the technical foundation of cryptocurrencies and how they work.