In 2011 Erik Finman, a 12 year-old from Idaho, received a $1,000 gift from his grandmother. Erik invested the money into Bitcoin, a sparsely known digital currency, which was then valued at $12.
Two years later Erik sold some of his original investment in Bitcoin for a whopping profit of $100,000. In August 2017, Bitcoin traded at $4600, making him a millionaire at the age of just 18 – all thanks to his original investment in a largely unknown new form of virtual currency.
Bitcoin was one of the first Cryptocurrencies created in 2009 as a type of digital currency which its anonymous inventor calls a peer-to-peer electronic cash system with decentralised government control. Today there are thousands of digital currencies available such as Ethereum, Litecoin and Dash with the list is rapidly growing.
What’s made Cryptocurrency so fascinating is its revolutionary concept and sharp rise in value which have made some investors – like Erik – millionaires in a very short space of time.
So let’s take a look at what Cryptocurrencies are, why they are so popular and how you can actually trade them.
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What is a Cryptocurrency?
A Cryptocurrency is a type of virtual or digital currency in which ‘encryption’ techniques are used to regulate its supply, help mask its transfer between parties and to which there is no central bank. It’s due to this ‘encryption’ that this digital currency finds its name – ‘Crypto’ currency – and is what makes them so innovative when compared to traditional forms of currency such as Pounds Sterling or the US Dollar.
The key differences between Cryptocurrencies and regular currency
- Digital only: Unlike physical cash, which you may carry around in your pocket, Cryptocurrencies such as Bitcoin or Ethereum are available in digital form only.
- Encryption technology: As previously mentioned, a key feature of Cryptocurrencies is their cryptography to secure transactions and control its supply.
- Decentralised: Perhaps one of the most attractive features of digital currencies is the fact Cryptocurrencies exchange hands on a purely peer to peer basis i.e. person to person without the need for a third party in between such as a bank. In this sense, it’s considered cheaper to send money to a peer than traditional forms for money transfers via a third party. It’s this decentralised feature that was one of the key factors in the early rise in popularity of Cryptocurrencies and it’s speculated that they were potentially being used on the dark web for transactions involving money laundering or terrorism.
- Blockchain: Due to its decentralised nature, Cryptocurrencies use a shared public ledger to record transactions known as a Blockchain. The blockchain is vital for the smooth running and stability of the whole Cryptocurrency system as it’s the only record of activity for when Cryptocurrency transactions are made.
- No central bank & supply: Traditionally the supply of currency is regulated by a Central Bank such as the Bank of England or US Federal Reserve. In Cryptocurrencies, no such central bank exists. Instead, some Cryptocurrencies have a limited supply such as Bitcoin. Bitcoin has a finite supply of 21m by 2140, and there are currently 16.5m in circulation. The way a user can create Bitcoin is via a term called mining, which is in essence the solution to a highly complex mathematical equation. Early adopters of Bitcoin were given a reward of an additional 50 Bitcoins to mine them successfully, thus incentivising the supply chain. Over time, the mathematical equation gets more and more complex, thereby reducing the supply significantly and in effect, regulating the market.
Why trade Cryptocurrencies?
First and foremost it’s important to note that Cryptocurrencies are perhaps the most volatile financial markets around today and are likely to remain so for some years to come.
To put this volatility into context, research from Cryptocurrency broker XTB shows that over the past two years the value of Bitcoin has increased by 68 times greater than that of the German DAX Index and 149 times greater than Gold. On any given day, the value of Bitcoin could rise or fall between 5% and 15%. This is not normal behaviour for a currency. To put that into context, the Pound Sterling fell 10% against USD and the EURO at one point the day after the UK voted to leave the EU, which was one of its biggest ever one day falls.
So you can see here that by comparison, these daily moves in Cryptocurrencies can be both lucrative and risky.
Why traders are so eager to invest in Cryptocurrencies?
- Innovation: As previously mentioned, cryptocurrencies are perhaps one of the biggest technological innovation since the dot.com boom. A truly decentralised currency system that operates on a purely peer to peer basis is revolutionary. Bearing in mind most traditional currencies have centuries worth of history, this new digital innovation remains in its infancy. Many investors are choosing to buy into this innovation.
- Fixed supply: Cryptocurrencies like Bitcoin have a fixed supply. Currently there are around 16m Bitcoins in circulation with 21m permitted by 2040. This limited supply could have the impact of encouraging further price growth, particularly if demand continues to grow and the crypto market begins to normalise i.e. become further entrenched within the global payments system. This lack of supply could also help reduce the risk of investing in cryptocurrencies
- Speculation: Put simply, most investors would be satisfied with a 5-10% return year on year in their investment portfolio. Indeed most major indices grow around 5% on average per year. Well from January 2017 to September 2017, the price of Bitcoin grew by more than 400%. So you can see by comparison many investors are trying to jump in on the crypto craze at the beginning in the hope that they will benefit from these sort of returns.
How to trade Cryptocurrencies?
So you’ve done your research, you know your Bitcoins from your Litecoins and now you’re ready to trade. How exactly do you do it? Well, there are two ways to trade Cryptocurrencies; via an exchange or a CFD broker. There are both positives and negatives between either options such as security, regulation, platform and leverage.
Trading Crypto via a CFD broker
Let’s look a little closer below at trading Crypto via a CFD broker.
There are a select few CFD brokers such as XTB who offer Cryptocurrencies via their trading platform and it’s perhaps a much more flexible way to trade Crypto for several reasons including:
Go long or short: traditionally via exchange you can only go long i.e. make money as Cryptocurrencies rise in value. CFD brokers enable you to go both long and short. By going short, you can essentially make money by speculating that Crypto markets will fall in value.
Multiple markets: CFD brokers offer multiple Crypto markets via the same platform as well as other asset classes such as stocks, indices, commodities and traditional forex. So you could treat them as a ‘one fits all’ broker.
Leverage: You can trade Crypto CFDs using leverage, meaning you can put your investment money into work more efficiently. For example, XTB offers Bitcoin at a leverage of 20:1. So for every $1,000 you have to invest, you can effectively get an exposure of $20,000 (i.e. 20 x 1). This becomes an important point should Cryptocurrencies like Bitcoin keep rising in value. Today it’s worth around $5,000. A year from now it could be worth much more than that. So if you only have a limited amount of money to invest, CFDs may be more of an efficient choice for you. It’s worth mentioning here that with leverage, as your exposure is greater than the money invested, your potential returns are magnified. All good if the markets go in your favour, but if they don’t, your risks are much greater too. So be careful.
Security: You’ve likely heard the stories about people’s Bitcoin accounts being hacked into and stolen. Well security is much tighter with a CFD broker and if you choose an FCA regulated broker like XTB, your money is protected by the Financial Services Compensation Scheme (FSCS) up to the first GBP 50,000.
Regulation: As we’ve explained already, physical Crypto trading is unregulated and decentralised. That has certain advantages in terms of the free movement of capital, but it also comes with the risk of lower protection for participants. As CFD trading is regulated, that means there’s a formal body looking out for you. Now certain regulators offer more protection than others. For example, the FCA – the UK regulator – has one of the best reputations around and is seen as a protector of retail traders.
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What are the popular Cryptocurrencies?
According to coinmarketcap.com, which lists volumes traded on the majority of cryptocurrency exchanges available, there are already more than 1000 different Cryptocurrencies to trade or invest in ranging from the first ever Cryptocurrency Bitcoin, Bitcoin Cash and Ethereum to the much lesser known KiloCoin.
Given the stories of those early investors in Bitcoin becoming millionaires within a mere few years, it’s understandable that a key factor behind this drive in Crypto creation is motivated by those wanting to make a quick buck. Not all Cryptocurrencies are worth investing in and some have been created purely for their founders to cash in on the Crypto craze.
So what are the key differences between these Cryptocurrencies and why are some more popular than others? Let’s take a look…
The first ever cryptocurrency and the most actively traded by volume in the world today, which has been a major factor behind its price surge. It also has the highest market capitalisation, at around $70 billion. One of the most popular features of Bitcoin for investors is the fact supply is currently around 16m but is limited to 21m by 2040.
Bitcoin cash (BTC)
A recent spin-off from traditional Bitcoin thanks to the famous forking process agreed by the Bitcoin community in August 2017. Bitcoin cash is meant to facilitate faster transactions, a common complaint about traditional Bitcoin. Upon launch, Bitcoin cash turned highly volatile so trade this one carefully.
Perhaps the second most popular Cryptocurrency, ETH is built on a different system to that on Bitcoin, with most Initial Coin Offerings (ICOs) being built on a similar system to Ethereum, not Bitcoin. ETH has the second highest market capitalisation at around $28 billion.
Litecoin is technologically very similar to Bitcoin, and is perhaps historically the third most actively invested in Cryptocurrency. However, Litecoin does come with some additional features when compared to Bitcoin, such as the adoption of segregated witness (as part of the transaction format) and the lightning network.
Utilises the same system as Bitcoin but this cryptocurrency has certain additional capabilities such as instant transactions and a decentralised governance.
Perhaps the biggest thing that sets Ripple apart from other Cryptocurrencies is the fact it’s being actively considered by some of the world’s major Central Banks, including the Bank of England and is already being used by major commercial banks such as UBS and Santander for settlement infrastructure.
Cryptocurrency Trading Strategies
So now you know what brokers to trade with and the differences between some of the major cryptocurrencies, how about some strategies to trade them? Remember that trading Cryptocurrencies is vastly different from traditional financial markets such as stocks or forex. Their price behaviour is different for a number of factors including:
- Volatility – perhaps the biggest factor to consider is that Crypto prices can move between 5% and 10% on a daily basis, making them one of the most volatile markets around. Considering this, it can make some strategies harder to perfect.
- Buzz & PR – a lot of drivers in Crypto can be news driven, such as speculation about a security hack or community debate. Again this can make it harder to trade and you may need to be quite reactive. In addition, many investors are currently buying into the Crypto craze based on the current tremendous price growth. Therefore, should there be any price shocks, it could be harder to predict how these inexperienced investors could react.
- New technology – Crypto is a new tech industry, and no one knows how it will grow or when digital currencies could ‘normalise’. Some talk about the Amazon day i.e. when Amazon starts accepting Cryptocurrency for payment, it will be an important milestone. But until then, this tech is still in its infancy and it’s hard to predict how it may progress in the future, or how governments will react. For example, China recently starting to block Crypto payments.
- ICO binge – there has been a notable Initial Crypto Offering binge with now more than 1,000 cryptocurrencies. This bears the hallmarks of the Dot com boom and bust, which was partly driven by a huge splurge in Initial Public Offerings of tech companies in 1999 and 2000, which was then shortly followed by a major stock market crash. Could we see history repeat itself?
- Supply – Some cryptocurrencies have limited supply, such as Bitcoin. When demand increases, this could have the effect of increasing prices. Compare this to the stock market where the shares offered on the public market are capped, unless more are offered via a corporate action. Again, something to consider when deciding your strategy.
- Volume – Some Cryptocurrencies have much less volume than others. For example, Dogecoin trades with much less activity than that of Bitcoin. The lower the average traded volume, the more susceptible that market is to volatile price action, so be careful.
- Technical drivers – Whilst it’s quite easy to see some technical indicators can be used, such as simple support and resistance, others such as Fibonacci or MACD may be less pertinent as technical indicators are partly driven by the amount of users and based on historical trading behaviour, which is lacking for many cryptocurrencies as they have only existed for a few years.
So now we know some important things to consider when choosing a strategy, what strategies could we consider for Crypto trading?
Trend is your friend
No matter what market you trade, the trend is your friend remains the common backbone behind most strategies. A trend is either when a market is moving higher (uptrend) or lower (downtrend). An uptrend is dictated by a series of higher highs and higher lows whilst a downtrend is a series of lower highs and lower lows. Essentially what a trader needs to do is determine if a market is in an uptrend or a downtrend and then look to trade in that specific direction, as it will commonly be the path of least resistance. For example, if a market is rising, then it makes sense to look for buy opportunities, as if the trend prevails, prices should continue to rise and your buy trade has more chances to become profitable.
Buy and hold
The traditional buy and hold strategy could be pertinent with Cryptocurrencies based on the fact their development and price action is largely still in its infancy stage. As long as your account is liquid enough to absorb the daily price volatility, then this could be a more calm way to trade Crypto than the more stressful attempts to try and pick the lows or highs
Some Cryptocurrencies with higher average daily traded volume have shown signs of range trading behaviour that could you help you pick the right time to enter a market. Range trading is when a market moves in a specific direction (up, down or sideways) with an upper and lower boundary. What you then try and do is go long when prices reach the lower boundary and short when prices reach the upper boundary, making the difference in between. If prices break out of the range, then you need to move on to a different strategy.
Support and resistance
Traditional support and resistance levels remain quite visible in certain crypto markets and across multiple timeframes. A resistance level is a specific level where prices have found difficulty rising above, and sellers typically emerge. A support level is a specific level where prices have found buyer support and not typically traded below. Typically this strategy would entail buying when prices reach support levels and selling at resistance levels. Should prices break above resistance, then the trade should be reversed, with a stop loss below prior resistance (which then becomes support). Should prices break below support, then the trader should be short this market with a stop loss above prior support (which then becomes resistance).
Buy the dip
This is when the trader believes a certain Crypto market will move higher over a longer period of time. Then the trader waits for periods when a price may correct i.e. fall 20% as an opportunity to buy at a lower price before the long term uptrend continues.
Sell the bubble
If you believe Cryptocurrencies are in a bubble, then you also believe that at some point in the future, that bubble will burst. If true, this could trigger a 40%-50% decline in prices so one strategy could be to identify when a market is at the upper limits of its bubble and sell it before the bubble bursts. There’s a number of both fundamental and technical features that can be used to help identify this, but importantly, there is no crystal ball indicator to determine when a bubble will burst. And it’s worth mentioning that if you are short a market hoping for a major correction, then the other side of that trade is the belief that prices are in a bubble i.e. moving rapidly higher. If that is the case, then there is a chance you could suffer major losses before the bubble bursts (with no guarantee that it will burst). So this is a particularly dangerous strategy.
Next steps – Try a Cryptocurrency Demo Account
Thank you for reading our complete beginners guide to trading Cryptocurrencies. By now you should have learnt what cryptocurrencies are, how to trade them, the best brokers to use and some of the strategies to consider. So what’s the next step? We recommend you test out trading Cryptocurrencies first using virtual money with one of our recommended partners below.
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