Basic Crypto Trading Strategy Part 1: Risk & Timing
Due to the relative infancy of the cryptocurrency market combined with its daily volatility and other unique characteristics, it is essential to cement a strong decision-making process before getting involved in trading.
What’s Your Crypto Risk Tolerance?
Every effective investment strategy begins by determining the appropriate risk profile, as often, this is the basis for picking the most effective strategy. As the chart below indicates, assessing the appropriate level of risk depends entirely on your investment objectives. Individuals seeking lower risks will often experience lower risk-adjusted returns whereas investors with a bigger appetite for risk may be able to reap higher rewards. The continuum highlights how the risk-reward tradeoff changes depending on risk appetite or aversion.
What’s Your Crypto Trading Time Horizon?
Apart from assessing the degree of risk you are comfortable taking, it is imperative to determine how short or long a time frame the intended crypto position will be held open. There are four main types of trading styles that emerge depending on the answer.
Scalping: Taken from the most literal definition of trading which is to buy low and sell high, traders employing a scalping style typically seek to exploit temporary mis-pricings in assets, holding trades open for as little as a few seconds to as long as a few minutes, but these trades are hardly held open for more than an hour. This is a common technique employed by algorithmic trading strategies that seek to repeatedly generate small returns with a high degree of frequency.
Day Trading: As its name would imply, this trading style involves holding positions open for up to one day, but not overnight. Like scalping, day trading seeks to take advantage of sharp intraday directional momentum, harnessing these moves for a slightly longer period of time that can last minutes or even hours. These opportunities could arise from significant order flow that creates temporary imbalances or even news which generates a change a sentiment. Similar to scalping, the idea is to generate a higher frequency of trades focusing on repeatedly capturing small returns.
Swing Trading: For this style, trades are typically kept open for days or even weeks depending on the opportunity. Swing trading depends largely on technical analysis to identify areas where a crypto asset is either oversold or overbought. This strategy largely ignores market fundamentals, instead choosing to focus on identifying proper entry and exit points before taking a position, establishing parameters for taking profit and stopping loss depending on the trading scenario.
Position Trading: By far the longest time horizon of the different trading styles, position trading takes a more long-term view of cryptocurrency assets all while incorporating fundamental analysis to a greater degree than other styles. Commonly referred to as a “buy and hold”, investors often keep positions active for months and even years depending on the conditions and circumstances, attempting to capitalize on long-term trends instead of repeatedly entering and exiting the market like other styles based on shorter trading time horizons.
Although this list is not exhaustive, it forms a template for starting to assess the appropriate trading strategy. By defining the time horizon and applicable risk profile, investors can hone in on the right criteria for building a strategy and eventually reaching their goals. In Part 2 of our series, we will discuss the importance of building a game plan to surpass these objectives.
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