13 March, 2019
With all the hype surrounding the cryptomarket since its spectacular rise in value in 2017, there are not many people who haven’t heard about cryptocurrencies, including the most popular – bitcoin. However, is trading bitcoin as you would any other financial instrument possible? Is it traded on Forex? How volatile is it? And how can I analyse it to make sensible trading decisions? This and much more will be discussed in this article. We’ll also include two complete trading strategies to trade bitcoin and other cryptocurrencies, and show you what to pay the most attention to on the cryptomarket. So, let’s get started!
Bitcoin is a revolutionary new product whose value is solely determined by the forces of supply and demand. The story began back in 2009, when an anonymous developer (or group of developers) named Satoshi Nakamoto developed bitcoin, authored the bitcoin whitepaper, and created the first database for bitcoin transactions. The real hype around Bitcoin started in 2017, when the cryptocurrency reached a record-high of around $20,000 and many people wanted to join the crypto-bandwagon. However, the price soon collapsed and bitcoin is now trading only at a fraction of its record price. The fall in value has also changed the approach that traders and investors use to trade bitcoin. Moreover, while a few years ago a buy-and-hold approach delivered the best results, times have changed and trading bitcoin CFDs is becoming increasingly popular using standard technical analysis tools. Traders who wanted to buy bitcoin had to go to a bitcoin Forex exchange, but nowadays many Forex brokers include cryptocurrencies in their range of tradeable assets.
There is still a lot of debate about whether bitcoin is a currency, asset, or something else. While many regulatory bodies and government officials don’t recognise bitcoin as a legal tender, it’s still possible to buy real physical products using bitcoin as a growing number of businesses are accepting cryptocurrencies, including Microsoft, Dell, and Virgin.
Bitcoin and other cryptocurrencies are based on blockchain, which is the underlying technology that makes the cryptocurrencies work. Many tech-giants have already recognised the value of blockchain technology, and new start-ups that use blockchain enter the market each day.
Let's take a quick look at the main characteristics of bitcoin and other cryptocurrencies:
Bitcoin is still far from being considered legal tender worldwide. Traders had to use specific crypto-exchanges to buy and sell bitcoin, but with the invention of bitcoin CFDs (Contracts for Difference), trading bitcoin has become significantly easier. Nowadays, many brokers even offer bitcoin trading with leverage.
Can you trade bitcoin on Forex? Not exactly. There is a notable difference between the Forex market and cryptomarket.
While bitcoin is not directly traded on the foreign exchange market, a growing number of Forex brokers include bitcoin CFDs in their range of tradeable assets to allow for bitcoin Forex trading. To trade bitcoin with a Forex broker, you need to find a broker that features cryptocurrency trading.
However, traders need to be aware that there are important differences between trading and valuing traditional currencies and cryptocurrencies. Forex traders know that anticipating the future move of a central bank can be a very tough endeavor, and the supply of a traditional currency can be suddenly changed or interrupted by unexpected market events. The supply of cryptocurrencies, on the other hand, is usually known in advance like in the case of bitcoin, where there is an exact amount of bitcoin that can be mined at a given point in time.
Another notable difference between the bitcoin and Forex markets is the way traditional currencies and cryptocurrencies are valued. With traditional currencies, such as the US dollar or Japanese yen, traders can use fundamental valuation models which derive the fair value of those currencies by using interest rates, inflation rates, and other macroeconomic data. With cryptocurrencies, on the other hand, traders have to rely mostly on technical analysis.
Just like trading any other CFD, you’ll need a trading platform to trade bitcoin CFDs. While there are many trading platforms to choose from, one of the best platforms remains MetaTrader 4. This is the most popular trading software for retail traders and offers great features as a bitcoin Forex trading platform. Some of the great tools that MetaTrader includes are listed below:
Bitcoin is an extremely volatile asset to trade. However, as traders we don’t have to fear volatility as this is what creates a profit opportunity in the first place. With increased volatility, money management becomes an increasingly important concept, so be sure to place Stop Loss orders on all of your Forex bitcoin trades.
Another important thing to consider is the position size of your trades and whether you are looking to trade with leverage. The price of bitcoin is heavily influenced by news, which can drive the price up or down by hundreds of dollars in a matter of minutes. If you take a large position size under such circumstances, you risk blowing your account or receiving a margin call if you’re trading on leverage. Make sure that your free margin is always large enough to withstand any negative price fluctuations.
Hint: Trading bitcoin is not much different from trading any other financial market. Risk only a small amount of your trading account on any single trade, and pay attention to the reward-to-risk ratio of your trades.
Now let’s take a look at a very powerful scalping strategy that can be used to trade Bitcoin and other cryptocurrencies on very short timeframes. The strategy is based on a combination of trend-following and mean-reverting techniques, and uses three indicators to find buy and sell setups.
1) 50-period and 100-period moving averages – These two moving averages are used to identify the short-term trend of bitcoin. A cross of the shorter 50-period MA above the longer 100-period MA signals an uptrend, while a cross of the shorter MA below a longer MA signals a downtrend. This is the trend-following aspect of the scalping strategy.
2) Stochastic indicator with a (5,3,3) setting – The Stochastic oscillator is used to identify overbought and oversold market conditions, which can signal a turning point in the current trend. In our strategy, we’ll use the Stochastics indicator to avoid placing buy trades when the market condition is overbought, and sell trades when the market condition is oversold.
A long entry is triggered when the faster 50-period MA crosses above the slower 100-period MA, signalling a short-term uptrend in bitcoin. This is the first condition which needs to be met. The second condition, which is very important to follow, is that the price makes a pullback to the 50-period MA and the Stochastic indicator moves from overbought conditions into normal conditions.
A Stochastic value above 80 signals overbought market conditions, while a value below 20 signals oversold market conditions. We need to wait for the Stochastic indicator to return from above 80 to below 80 to enter with a long position. Opening a long position when the markets are overbought can be considered risky, despite the fact that markets can remain overbought or oversold for a significant period of time. This is done to increase the overall profitability of the scalping strategy.
As the picture above shows, a long entry is executed when all three conditions are met – the faster MA crosses above the slower MA, the Stochastic oscillator returns from overbought market conditions to below 80, and the price makes a pullback to the moving averages.
The scalping strategy returns a short signal when the 50-period MA crosses below the 100-period MA, signalling a short-term downtrend. Besides this condition, the price also has to make a pullback to the 50-period MA (return and touch the MA), and the Stochastic indicator should return from oversold market conditions (below 20) to normal conditions (between 20 and 80). When all these conditions are met, we can enter with a short position in bitcoin CFDs.
This scalping strategy usually returns the best results when used on very short timeframes, such as the 1-minute or 5-minute timeframes. Stop Losses should be placed just above the recent swing high in the case of short positions, or below the recent swing low in the case of long positions. Profit targets should be at least the size of the Stop Loss, returning at least a 1:1 reward-to-risk ratio.
A short entry is shown on the chart above. As you can see, all three conditions are met – the fast-slow MA crossover, the price pullback to the MAs, and the Stochastics indicator with a value of above 20. As usual, scalping strategies aim for a large number of trade signals during the day with relatively small profit targets.
Day trading bitcoin CFDs is not much different from day trading other financial instruments. What you want to do is look out for familiar chart patterns, for breakouts of support and resistance levels, follow the overall trend, or trade the price corrections of an established trend. In this regard, there are three main ways to day trade bitcoin CFDs.
In this day trading style, we would look for breakouts around familiar price ranges and chart patterns such as Head & Shoulders, double tops and bottoms, various triangle patterns, or channel and trend line breakouts, to name a few. A breakout is usually followed by a significant buying or selling momentum in the direction of the breakout, and day traders aim to catch this momentum and profit on it. To do so, day traders often use pending orders such as Stop and Limit orders, with the execution price set just above or below the anticipated breakout level.
The chart above shows a typical breakout trade setup on bitcoin based on a symmetrical triangle pattern. Breakout traders would like to catch the breakout as soon as it happens, with a profit target equal to the height of the triangle pattern itself.
A trend-following day trading approach is based on trading the underlying trend of the cryptocurrency. While this used to be an extremely profitable approach a few years ago when the crypto-market knew only one direction – up – nowadays most cryptocurrencies are ranging, and a breakout approach would likely produce better results. However, if a new trend in bitcoin is established, characterized by higher highs and higher lows in uptrends or lower lows and lower highs in downtrends, a trend-following trading approach could again be a viable strategy.
A simple trend-following setup based on the 4-hour timeframe and a falling channel is shown on the chart above. Each time the price comes close to the upper edge of the channel, a Sell Order could be executed. Under this approach, it’s important that the price hit consecutive lower lows and lower highs during a downtrend, or higher highs and higher lows during an uptrend.
Finally, bitcoin can also be traded with a countertrend approach which refers to catching price corrections which go against an established trend. Given the price volatility of the crypto-market and its strong and long-lasting trends in the past, I wouldn’t personally recommend this trading approach as it involves significantly more risk than a breakout and trend-following approach.
While we mostly covered bitcoin in this article, other cryptocurrencies don’t differ much. Coins like litecoin, ripple, ethereum or bitcoin cash all exhibit similar price patterns and behaviours like bitcoin, and traders are free to trade those cryptocurrencies which show the best trade setups. However, bear in mind that most so-called altcoins are positively correlated with the price of bitcoin – when bitcoin goes up, most altcoins go up, and when bitcoin goes down, other altcoins usually follow.
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