Understanding Crypto Trading Strategies

To navigate the crypto markets and trade with success, it’s important to develop a strategy that you can backtest and refine over time. This article will go over the different elements of a trading strategy and provide you with some ideas in formulating your own unique approach.

Outline

  • What is a Trading Strategy?

  • What is Scalping?

  • What is Day Trading?

  • What is Swing Trading?

  • What is Position Trading?

  • Passive Trading Strategies

What is a Trading Strategy?

Just like in sports, business or any other competitive field, a good strategy can be the difference between success and failure. The importance of strategizing cannot be understated, as a trading strategy is a set of rules and practices that gives you direction by specifying your aims, the markets you’ll trade, and your risk tolerance.

When setting these factors beforehand, a strategy can help you enforce discipline and trade in a systematic way, eliminating guesswork and emotions from the trading process. Without a strategy, you may make decisions on a whim without much thought and sticking to your plan ensures that you only take action when the best opportunities present themselves.

In short, a piece of advice traders should always keep in mind:

“Plan the trade and then trade the plan”

Every person is unique and so too are the strategies used by traders in the cryptocurrency market. Your personality, lifestyle, world view and talents all have a bearing on the optimal way for you to trade crypto. Also, appetites for risk vary across different people, which will impact which trading setups they will take or avoid.

There’s no one size fits all strategy to help you to become a successful trader, so you’ll have to use the advice in this article to figure it out yourself, but it’s better to have a map rather than none at all and that’s exactly what a trading strategy is: a map to guide you through the markets, laying out the conditions or scenarios when you should avoid trading as well as the situations where you should take a trade.

Some of the factors that are worth considering when developing a trading strategy are:

Some of the tools mentioned above actually overlap. For example, while Dune could be seen as a pure fundamentals approach, it can also be used as a tool for sentiment by looking at the trend dashboards, to see what other people are most interested in. Wherever most people’s attention is, it is likely that the volume required for big moves will follow.

  • Triggers for trading entries: you’ll need to establish a method to determine when to enter a trade by using the tools or indicators you have chosen for your strategy. For example:

    • Technical traders may use a confluence of indicators to go long, such as when there’s a bullish crossover in the 50-day and 200-day moving averages and trading volume is rising.

    • Fundamental traders may go long whenever the market valuation is lower than the fundamental value, which can be determined using indicators such as the network value to transactions ratio, the market value to realized value ratio and other similar measures of fundamental value.

    • Sentiment traders may go long when social activity for a particular token starts to gather momentum or if they notice a lot of whales are accumulating a token.

  • Conditions for exiting a trade: setting a level where the trade idea fails and a level to take profits. Just like setting a trigger for trading entries, the conditions for exiting a trade will be related to the approach you take, i.e., whether you are more focused on technical, fundamentals or sentiment.

  • How you track your performance: Trading strategies should evolve over time as market conditions change, so it’s important to backtest your strategy before using real money and then track your performance to iteratively improve over time.

Another key part of a trading strategy is your style and how often you trade. In the next sections, we’ll explain the following trading strategies as well as the pros and cons of each: scalping, day trading, swing trading and position trading.

What is Scalping?

This strategy focuses on capturing a high number of very small price movements, getting in and out of trades in quick succession. Scalpers only hold their positions for very short durations, typically utilizing the 1-minute, 5-minute and 15-minute charts. Sentiment is also an important factor, as it can shift very quickly.

A scalpers job is to capture as many small price movements as they can during the times of day when volume is greatest. Smaller fluctuations happen more often, which provides more potential opportunities than other types of strategies. If you have a busy, demanding lifestyle then scalping may not be best suited to you as you have to remain focused on the charts and put in a lot of time. You need to be able to think and act quickly.

Even if you have the time and quick decision making skills, it's important to keep in mind that the aim of scalping is to generate lots of small wins that accumulate over time. If you’re looking for less frequent, but bigger wins, you may want to consider taking a different approach.

Another factor to take into account is that scalpers tend to use larger position sizes to generate profit from small movements. Therefore, if you have a small amount of capital to start with, then other trading styles may be more suitable.

If you decide to utilize scalping, then you should only trade the most liquid pairs to reduce price slippage and only enter positions during the most liquid times of the day when there’s a lot of activity.

Pros & Cons of Scalping

Pros

  • Less of a need to dive into fundamentals, since they don’t play a significant role over very short timeframes. These traders do not need a lot of knowledge about the asset they’re trading.

  • Scalping can generate profits very quickly, so it may be good for those traders who do not have a lot of patience.

  • Since positions are only held for very short periods of time, there’s less chance that a reversal will occur that will go against your position. Less patience required, since trades tend to be closed in a matter of seconds or minutes.

Cons

  • There’s more noise in the markets over shorter timeframes and it’s more likely that you will get false signals. More precision is required for entries and exits, since scalping requires fast decision-making and reaction skills.

  • Requires a lot of screen time and a laser focus as a small price movement can be the difference between a profitable trade or a loss.

  • Since you’re trading frequently, the fees to open and close positions may add up to significant sums over time.

  • Unless trading with large size, it can take longer to reach your financial goals and generate meaningful profits. Since stop losses are tighter on lower timeframes this also means potential profits will be smaller.

What is Day Trading?

Day trading involves entering and exiting positions on the same day, capitalizing on intraday price movements and typically using timeframes ranging from 15 minutes to 4 hours.

These types of traders, like scalpers, tend to focus more heavily on technical analysis and sentiment analysis. However, fundamental analysis is also important for these traders since breaking news stories can impact the market on a day-to-day basis.

While less time intensive than scalping, day traders still require the time to analyze the markets at the beginning of each day. Once the trades are placed, you’ll still need to monitor the position throughout the day.

Pros & Cons of Day Trading

Pros

  • Fast-paced which may be suitable for those looking for quick results.

  • More potential opportunities than longer-term trading styles.

  • No overnight risk: since positions are opened and then closed within a day, there’s no risk carried overnight, where a big news story or development could move the market against your position.

Cons

  • Requires more patience than scalping.

  • Risk of overtrading and there’s a heavier mental burden since you have to change your market views more frequently.

  • While day trading doesn’t require as much screen time as scalping, you’ll still need to dedicate enough time to analyze the markets and monitor your positions.

What is Swing Trading?

Swing trading is a longer-term strategy that takes advantage of trends that play out over several days or even weeks.

The name of this style comes from the fact that a swing trader tries to identify the ‘swing low’ (a major price low) and ‘swing high’ (major price high) points. With this style, you have more time on your side to assess your decisions and react to how the market is unfolding as compared to scalping or day trading.

This style of trading tends to focus heavily on both fundamentals and technicals, utilizing the 4-hour, 1-day and 1-week charts. The aim of swing trading is to generate profit over a very small number of trades by riding trends to their full extent, with positions opened less frequently than a day trader or scalper.

Pros & Cons of Swing Trading

Pros

  • Trading signals on daily charts are usually more reliable than signals on lower timeframes.

  • Less screen time required as the trade is active for a longer period of time. Swing traders do not need to constantly monitor the charts, they can typically check a few times per day or on each daily close.

  • Since swing traders aim to capture larger price movements, lower leverage levels can be used to reduce the risk of liquidation and stop losses can be larger to give the trade more breathing room.

Cons

  • While less screen time is required, there’s a higher chance that the market will move against your position since positions are held for longer durations.

  • Fewer trades over time as compared to scalpers or day traders, so there’s less margin for error as one bad trade could set you back.

  • You may miss out on profits over the long-term if the price of an asset continues in your direction in the following months. Because swing traders typically get in and out of positions within a few days or more, exiting too early means they may miss out on a long-trend trend.

What is Position Trading?

Position traders buy or sell an asset based on a trend they’ve identified, holding their positions for very long durations (at least a few months), ignoring day-to-day fluctuations.

Because of their focus on longer timeframes, this style tends to rely heavily on fundamental analysis by looking at the underlying health of blockchain networks to make their trading decisions. Technical analysis can also play a role, with position traders typically looking at the one-week or one-month charts to set up their trading plan, their stop loss, entry and exit. Sentiment plays a very minor role, if any role at all for these traders.

Compared to ‘buy and HODL’ investors, position traders may go long or short, which gives them more flexibility in expressing their market views.

Pros & Cons of Position Trading

Pros

  • Position trading is not time intensive: identify a trend and manage the position until the long-term trend has been exhausted. The lighter demands means that this method is more suited to someone with a busy lifestyle as you have more time to build your ideas.

  • Since position traders want to profit from long-term trends, they do not need to enter large position sizes, as the potential profit from holding a position over the course of several months or even years is much larger as compared to day trading or swing trading.

  • As a result of the two advantages explained above, position trading can be a good starting point for beginners who want to learn and test out their skills. Along with potential profits being higher, stop losses can be larger giving your trade more breathing room.

Cons

  • The capital used for position trading becomes unavailable for long periods of time, which could be better used elsewhere. A lot of time is required to see whether your trade has been confirmed or becomes invalidated.

  • In crab markets where the price is stuck in a range, position trading is less effective as there’s no clear long-term trend.

  • Funding fees will add up over time and accumulate for position traders with perpetual swap positions, which may eat into their profits.

  • While stop losses provide more breathing room for your trade and potential profits may be larger, the flipside is that the magnitude of losses will be larger (although less frequent).

Passive Trading Strategies

While we have covered active trading strategies in the preceding sections, there are also passive trading strategies you can implement that require less attention and time. One of the best examples is the ‘buy and HODL’ strategy, where traders buy assets as a long-term investment and do not require the investor to monitor the markets on a day-to-day basis.

Another well-known example in the crypto space is dollar cost averaging (or DCA), a passive strategy that involves buying or selling an asset at fixed intervals to average out your cost or profit basis. Passive DCA strategies can be executed on Optimism using Mean Finance. Index investing is another option, where investors can gain exposure to a basket of cryptocurrencies to engage in thematic investing. For example, Nested.fi allows you to create and invest in user-created portfolios on Optimism.

In summary, a trading strategy serves as a map to guide you through the markets and setting certain conditions for placing and executing trades will help you to make more informed decisions. Before trading with significant sums, you should backtest your strategies and then once you have found an edge, regularly track your performance to improve your approach over time.

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