Cryptocurrency Trading 101

Cryptocurrency trading refers to the different processes of exchanging one cryptocurrency for another cryptocurrency in a bid to make profit. The process of cryptocurrency trading is possible because cryptocurrencies as asset classes are valued at a certain price level and these prices tend to fluctuate based on the interaction of demand and supply for that cryptocurrency asset. The cryptocurrency market just like other financial markets such as the stocks and forex markets experiences very high levels of volatility, therefore sharp fluctuation in price of these cryptocurrency assets is mostly a characteristic, these fluctuations in price presents an opportunity for market participants to profit.

A large part cryptocurrency trading usually takes place on cryptocurrency exchanges which could either be centralized or decentralized depending on the mechanism of operation. Cryptocurrency trading could also occur over the counter(OTC)  or it could be Peer-to-Peer either through an automated environment like Binance peer-2-peer or manually between parties involved on the exchange.

Whatever form or wherever cryptocurrency trading activities takes place, it is important to understand that the process of cryptocurrency trading could involve the exchange of one cryptocurrency asset for another cryptocurrency or the exchange of a cryptocurrency asset for fiat currency or other asset class. 

To be able to get started with cryptocurrency trading, it is important to understand the basic concept of some cryptocurrency trading terms.

Cryptocurrency Tickers

Every cryptocurrency has a name by which participants in the crypto market generally know them to be. These names are based on what the team behind the cryptocurrency project thinks should be the name of the project they are building. In addition to names of cryptocurrencies, there are also acronyms used to represent them, these acronyms which can be alphanumeric are referred to as tickers. Cryptocurrency exchanges use these tickers for easy reference to cryptocurrency pairs. Example is BTC used to represent Bitcoin as ETH is to Ethereum.

Cryptocurrency Trading Pair

Fiat currencies mostly have a means by which they can be expressed in smaller units, for example the smallest unit for the British Pounds is called Penny while that of the US Dollar is called Cent. This small unit helps it possess characteristics of money known as unit of account. Cryptocurrencies also as a form of digital currency are also divisible and can be expressed in smaller units, for example Bitcoin which is the first successful cryptocurrency has its smallest unit known as Satoshi or Sat , a unit of Satoshi is equivalent to 0.00000001 Bitcoin.

Let’s take a closer look:

1 Sat is equal to 0.00000001 BTC

So 35 Sats is equivalent to 0.00000035 BTC

There are 100 million Sats per Bitcoin

• To convert Bitcoin to Sats, you add commas from the right:

1.02345678 BTC= 102,345,678 Sats

• To convert  Sats to Bitcoin, add zeros to the left:

346,846 Sats= 0.00346846 BTC

Since the smallest unit if Bitcoin is measured in Satoshi, many different cryptocurrency are also measured according to this standard when used as trading pairs.

Cryptocurrency trading pairs are just values of one cryptocurrency to another cryptocurrency or fiat currency expressed in Sats.

Example:

ETH/BTC: 0.03411500

ETH on the left is called the Base Currency

BTC on the right is called the Quote Currency

What this means is that ETH is sold at 34,115 Sats.

Order Book

We have mentioned earlier that cryptocurrency trading activities mostly take place on cryptocurrency trading exchanges, these exchanges are automated environments that match buyers and sellers together. One tool that is often associated with the matching system of buyers and sellers of cryptocurrency assets on these exchanges is the order book.

The order book is the arrangement and collection of available buy and sell order for a cryptocurrency asset organized by price. Trading cryptocurrency is an activity engaged in by many people from different part of the world, whenever any on of these persons places an order, either buy or sell order, for a cryptocurrency asset, it gets added to the order book and will stay there until that order gets filled up.

The working mechanism of the order book system is that of a matching engine, that is buy orders are matched with sell orders of participants on these exchanges. For an order on the order book to be filled, there has to be another participant on the other end of the order book willing to take it at that price level.

Types of Order

When trading cryptocurrencies on exchanges, buying and selling activities are not directional, it is not possible to predict with certainty how the market will react as there are a lot of people with different ideas and opinion on what the price of a cryptocurrency asset should be, therefore exchanges provide tools that allows traders to buy and sell cryptocurrencies at prices that is convenient for them, provided the market takes the price to that desired level.

These tools are usually referred to as order types and we will be looking at three most widely used order types found on cryptocurrency exchanges.

Market Order

This is the type of order type that allows cryptocurrency traders to buy and sell cryptocurrency assets at the best available price for that cryptocurrency asset. For example, if the price of Bitcoin is currently at $50,000 and you want to buy with the market order feature, it will allow you to buy at that exact price of $50,000 not more, not less.

Limit Order

The limit order feature is another order type that allows traders to buy a cryptocurrency below the current market price and also allow traders sell above the current market price. A limit order gets filled when the market takes the price of that crypto asset to that price level.

A practical example of how the limit order works will be when you want to buy Bitcoin, if the current market price is pegged at $50,000 but you want to buy lower than $50,000, say, $48,000, the limit order feature can allow you place your at that price level, whenever the market get the price to that level, your order will get filled allowing you buy Bitcoin at $48,000 automatically.

Stop-Limit Order

Stop-limit is the order type that allows you to buy higher than the current market price and sell lower than the current market price. Let say you are in a trade for BTC which price is $50,000 now, and you set your limit order to sell at $51,000 because you feel the price will reach there, but you have a feeling that if the price breaks through $51,000 it will go higher, your stop-limit order can be set to buy at a higher price if BTC breaks $51,000.

Types of Cryptocurrency Trading

It is already a well established fact that cryptocurrencies can be traded for the purpose of profit making. The volatility of the cryptocurrency market in combination with price fluctuation of these crypto assets makes it possible for them to be traded for profit.

The expansion of the cryptocurrency market due to the adoption and application of cryptocurrency and blockchain technology to various industries has made it possible for many people from around the world to get involved in cryptocurrency trading actively. As a result of this increase in the number of  market participants, many new methods of engaging in cryptocurrency trading have been developed, new exchanges have been built all in a bid to provide these market participants a means of trading these assets easily.

These exchanges provide various ways of trading crypto assets for market participants based on their preferred choices. There are exchanges which offer crypto trading tailored to just over-the-counter traders while some others  are fundamentally peer-to-peer in their operation.

For the purpose of this article we will have cryptocurrency trading classified into two methods namely: Spot Trading and Derivative trading or Futures. These two methods of trading form the different established ways traders trade cryptocurrency for profit. Most cryptocurrency exchanges tend to offer just spot trading activities but recently derivative trading functions have started to see implementation in most exchanges.

We will take a dive into the concept of spot trading and derivative trading for cryptocurrencies.

Spot Trading

The most basic way of trading cryptocurrency assets is to buy them through informed analysis at a lower price and sell them at a price higher than your purchased price level. This process of buying crypto assets at a low price and selling high represents the spot market trading for cryptocurrencies.

Spot market for cryptocurrencies is where crypto assets are traded for immediate delivery. For example, if the current price of Bitcoin is at $50,000 and you bought it at that price, if the price moves from $50,000 to $51,000 and you sell at that price level, you will make a profit of $1,000. Although if the price action goes in the opposite direction and the price of Bitcoin ends up at $49,000, you will be at a loss of $1,000 even though you will still have your unit of Bitcoin you bought.

Spot trading is generally considered to be a much less risky method of trading cryptocurrency assets, as at every instant where you are in loss or in profit based on price fluctuations, you would always have your crypto asset you purchased. It is a classical case of “you only gain or lose when you sell off”.

Derivative Trading/Futures Trading

For spot trading, you have to buy a cryptocurrency at a certain price and wait for this price value to go higher than your entry price. You lose the value of your trading capital if the price of that crypto asset falls below your entry price and you would have to keep holding that asset until it rises above your entry price for you to make profit.

Derivative trading for cryptocurrency works very differently from the spot market trading methodology. Here, you don’t buy and hold any cryptocurrency asset; instead what is done is more like predictive trading. Derivative trading allows you to make informed assumptions about the price movement of a cryptocurrency asset using leverage functions provided by the exchange.

If the price movement goes according to your prediction, you make profits on your trading capital based upon the leverage you used but if the price movement you predicted goes wrongly, you make losses on your capital based also upon the leverage value you decided to use.

Let’s take a look at a practical example:

Let’s assume the price of Bitcoin is at $50,000 now. After you had done some analysis on the price of Bitcoin, you came to a conclusion that the price of Bitcoin will go higher from the $50,000 price level. If you decide to trade Bitcoin on the derivative market using a leverage value of X10, what this means is that by whatever percentage the price of Bitcoin multiplied by the leverage value is the profit you will get based on your trading capital.

Therefore if the price of Bitcoin increases by 1%, you will make 10*1% which is a 10% increase on your trading capital. If this increases by 2%, you make a 20% profit. If this trade does not go according to your analysis and the price of Bitcoin decreases from $50,000 by 1%, you will make a 10% loss on your trading capital. If this loss continues, it gets to a certain price level where you lose all your trading capital.

Derivative trading is also referred to as futures trading.

Terms used In Derivative/Futures Trading

To understand the cryptocurrency derivative trading market properly, there are a few terms that need to be understood properly. We will take a look at each one of them briefly here.

• Crypto Derivative/Futures: This refers to the agreement to purchase or sell a crypto asset at a set price level. This agreement allows market participants to earn profits from these crypto assets without the need to actually own the asset directly.

• Leverage: Leverage is an advanced investment strategy, it requires that a trader takes a short term loan to fulfill their trade prediction. In this way crypto traders can gain access to larger trading funds without the need to fully pay for the crypto asset upfront. Leveraged traders will only need to pay a small deposit when they open a trading position. This deposit is called a margin. Leverage value can between 1-100 depending on exchange you use.

• Margin: Margin refers to the initial deposit a derivative trader puts up to open and maintain a leveraged position. Margin requirements vary from one exchange to another exchange.

• Longing: When you go long trading cryptocurrency, what this means is that you are predicting the price of that cryptocurrency asset to go higher from your entry price level. If the price goes higher, your profits equals your utilized leverage value multiplied by the percentage increase in price of the crypto asset. If the price of that asset goes lower, your loss equals your utilized leverage value multiplied by the percentage decrease in price of that asset, all based on your trading capital.

• Shorting: shorting with respect to crypto derivatives means that you are predicting the price of a crypto asset to go down from your entry price level. If the price goes down, your profit equals your chosen leverage value multiplied by the percentage decrease in price of that asset. If the price of that asset goes up, you incurred losses equal to your chosen leverage multiplied by the percentage increase in price of that asset, all based upon your trading capital.

• Liquidation Price: When trading crypto derivative market, there is a price level which your wrong prediction gets to and you lose all your trading capital or what is called your initial margin. Liquidation price level depends on the leverage value you use, the higher the leverage value, the closer the liquidation price and vice-versa.

Cryptocurrency trading is a very profitable niche but to be successful at it, one must learn how to do proper trading analysis and manage risk properly.

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