Cryptocurrencies have drawn the interest of both short-term traders and long-term investors. While experienced traders and investors may have no problem adding crypto to their repertoire, those that are new to the financial markets may not know where to start with either building a long-term portfolio or identifying short-term opportunities.
Let's take a look at two specific strategies that beginners can use to trade and invest in cryptocurrencies.
Long-term Investment Strategy
Long-term investors are interested in capitalizing on price changes over the course of several years rather than day-to-day volatility. In addition, many investors are interested in cryptocurrencies as a diversification tool given their lack of correlation with conventional financial assets, such as stocks, bonds, or even precious metals like gold.
A popular long-term investment strategy is to build a market capitalization-weighted portfolio of cryptocurrencies for diverse exposure to the space. Many indexed exchange-traded funds (ETFs), such as S&P 500 index ETFs, use this approach to achieve diversified exposure to a given market without the need to invest a lot of time and energy in fundamental analysis.
How It Works
Start by looking at the top five cryptocurrencies by market capitalization. Then, sum the market capitalizations and calculate each cryptocurrency's percentage of the total.
Cryptocurrency Market Capitalization Weight (% of Total)
Data as of December 16, 2019
Determine the amount that you're willing to invest each month, quarter or year into the portfolio and multiply it by each percentage to calculate the investment amounts. For example, if you want to invest $10,000 per quarter, you would invest $8,060 in Bitcoin ($10,000 x 0.806), $930 in Ethereum ($10,000 x 0.093), and so forth until the $10,000 is fully invested.
Tips to Keep in Mind
Investing on a regular basis, rather than all at once, enables you to benefit from dollar cost averaging. Bitcoin prices could be high one month and low another month, but if you've invested an equal amount in both months, you will have an average cost basis for your holdings. You can avoid the need for 'luck' and have less of an emotional rollercoaster ride.
If cryptocurrency prices change over time, you may also want to consider rebalancing the portfolio. The rebalancing process involves calculating the current market share of each cryptocurrency in your portfolio and comparing it to the market capitalization weights in the market. You can buy or sell cryptocurrency to bring your portfolio back into line.
Short-term Trading Strategy
Short-term traders are invested in capitalizing on short-term price movements over the course of a few hours or days. They are less concerned about long-term fundamentals and more concerned about short-term profits. In fact, they may rely on the income as either their full-time job or a side income to supplement their earnings from another job.
The key difference between traders and investors is that trading is not a passive activity — it requires a substantial time commitment. Most traders lose money in the market — or at least fail to outperform long-term passive investors — but those that are successful find the career very rewarding since it's both exciting and intellectually challenging.
How It Works
A common trading strategy is to buy a cryptocurrency when momentum starts to increase and sell it when the momentum starts to wane. You can measure this momentum using statistical analysis with technical indicators or by looking at the underlying market psychology with chart patterns. Many traders combine both of these techniques in practice.
The relative strength index (RSI) is a popular momentum indicator that measures the magnitude of the gain or loss in a current period to that of a look-back period. If the RSI rises above 70, the cryptocurrency is considered to be overbought and could see a near-term decline. If the RSI falls below 30, it's considered oversold and could be due for a rebound.
After identifying a cryptocurrency with an RSI below 30, you may look for a significant breakout from trend line resistance as a signal to buy. The breakout could represent a bullish change in momentum following a period of decline. You might set a take-profit target at the next major resistance trend line, as well as watch for an RSI reading above 70.
Tips to Keep in Mind
Many traders incorporate technical indicators into automated trading systems or use crypto scanners to alert them to opportunities in real-time. While these tools can simplify due diligence, it's important to realize that past performance doesn't guarantee future performance and you will need to constantly tweak trading systems to retain effectiveness.
Psychology also plays an important role for traders. In addition to knowing technical indicators and chart patterns, you need to have a well-defined trading system in place to ensure that you're following your own rules. It's easy to lose confidence in the moment and prematurely buy or sell cryptocurrencies, which can result in unexpected losses.
Leveraging the Right Tools
There are many different strategies for long-term investors and short-term traders to capitalize on the cryptocurrency market, but it's easy to forget about some of the ways to generate 'guaranteed returns' by reducing risks or lowering costs. These small efforts can have a significant impact on after-tax returns, which makes them an important first step.
ZenLedger helps minimize costs and enhance after-tax returns by automatically aggregating transactions across multiple exchanges and wallets and calculating capital gains and losses. These gains and losses are automatically sorted into long-term and short-term categories to determine the correct tax rates. Popular IRS forms are then pre-populated with the necessary information.
In addition to accurate reporting, ZenLedger makes it easy to take advantage of tax-loss harvesting strategies that can reduce your tax liability. The strategy is simple: You sell losing positions to realize any losses and immediately repurchase them to re-establish the position at a new cost basis. That way, you can 'write off' losses and defer gains.
The Bottom Line
Cryptocurrencies have become popular among both traders and investors. If you're new to the market, you may want to consider strategies such as those outlined in this article to help you get started. It's also a good idea to consult with a financial advisor, tax planner, and/or other professionals to ensure that you're on the right track.
ZenLedger and other tools can help you further increase your after-tax return by ensuring that you're accurately reporting taxes (avoiding potential fines and penalties), while helping you take advantage of tax loss harvesting to realize losses now and defer gains until later.