Imagine trying to bake a cake by tossing a bunch of ingredients into a bowl, throwing it into an oven, and hoping for the best. While well-trained chefs may be fine with this approach, most of us need a specific recipe detailing everything from the ingredients to the baking times. Otherwise, we’d end up with an inedible mess.
The same goes for trading cryptocurrencies. While you can try buying and selling based on a hunch, it’s better to follow a carefully planned strategy specifying when to buy and sell, how much risk to take, and how much capital to invest. That way, you can produce consistent results and fine-tune your recipe to improve results over time.
Why You Need a Strategy
A trading strategy is a set of rules and guidelines a trader follows when deciding what trades to make. You can base these rules on technical analysis, fundamental analysis, quantitative analysis, or a combination of factors. While some traders prefer to trade instinctually, many successful traders take a more systematic approach.
A well-designed trading strategy can help in the following ways:
- Emotional Control – Trading can be an emotional rollercoaster. The fear of missing out or panic selling during a downturn can lead to poor decisions that negatively impact your investment. A pre-defined strategy helps mitigate these emotional responses because you’ll know in advance what actions to take in any market.
- Trading Consistency – A trading strategy offers a structured approach that makes your trading activities more consistent. Over the long term, this ensures you’re not haphazardly changing your direction based on the latest market trends or news.
- Performance Measurement – A clear strategy makes it easier to track your trades’ performance and adjust your plan as needed. Therefore, you can understand whether your system works and what you need to change to improve your results.
- Risk Management – A good trading strategy provides clear guidelines for managing risk, such as setting stop-loss orders to limit potential losses or only investing a certain percentage of your portfolio in any single trade.
1. Buy-and-Hold (HODL)
Cryptocurrencies have become infamous for their volatility, so early traders coined the term “Hold On for Dear Life” (HODL). Rather than buying and selling, these traders buy-and-hold cryptocurrencies through volatility and over time. They believe crypto will eventually become a mainstream phenomenon, unlocking tremendous value.
Buy-and-hold investors typically use fundamental analysis to select investments. For example, you might read altcoin whitepapers to find promising projects, dig deep into source code, or find other ways to assess the potential for different projects. The goal is to buy and hold these tokens while they build an ecosystem and accumulate value.
2. Dollar-Cost Averaging (DCA)
Many long-term investors also leverage “dollar-cost averaging” (DCA). Rather than making a one-time investment, you can invest small amounts on an ongoing basis to even out your cost basis over time. For example, if you invest $100 when a token is $1.00 and another $100 when a token is $0.75, your cost basis is $0.875.
Dollar-cost averaging can help in both market conditions. In a falling market, dollar-cost averaging can lower your cost basis over time, enabling you to realize more profit if the price recovers. Meanwhile, the same strategy can help reduce the chance of buying at a high or selling at a low by averaging your trades across multiple prices.
3. Trend Trading
Trend trading is one of the most popular strategies leveraging technical analysis. Based on the idea that “the trend is your friend,” the strategy identifies and follows an uptrend or downtrend (across multiple timeframes) until it shows signs of reversing. The goal is to capitalize on price momentum until there’s a change in overall market sentiment.
Trend traders typically look at moving averages, trend lines, and momentum indicators to spot opportunities. For example, a trend trader might draw a trend line connecting a series of low prices to create an upward trend, buy the token, and only sell when the price breaks down through the trendline, indicating a potential reversal.
4. Swing Trading
Swing trading refers to strategies that capture gains over a few days to several weeks. Using technical analysis, swing traders look for short-to intermediate-term opportunities. For instance, selling a token as it breaks down from an uptrend.
A typical swing trading strategy might involve looking for reversals using chart or candlestick patterns. For example, you might look for a head and shoulders pattern suggesting a bearish reversal or a bullish engulfing candlestick indicating an imminent move higher. These patterns represent changes in market sentiment or emotion.
5. Day Trading
Day trading involves placing trades that start and end within the same day. While crypto markets don’t “close” like stock markets, day traders never leave an open position while they sleep. They also employ much more leverage than other traders, meaning they’re more exposed to large price swings.
Many crypto day traders look for arbitrage opportunities or use other low-risk strategies. For example, they may find that two exchanges offer the same token at different prices. By buying on the lower exchange and selling on the higher, they can profit from the difference when the prices eventually equalize.
What’s Right for You?
Choosing the right trading strategy depends on your risk tolerance, time availability, capital, market knowledge, and trading skills. Each strategy has its own risk and reward profile, and what works well for one trader might not work for another. It’s usually a good idea to “paper trade” (fake trade) different strategies to discover what works best for you.
At the same time, it’s possible to combine different strategies or switch between them depending on market conditions. You might use trend trading strategies for tokens experiencing significant long-term upswings or downtrends and day trade more obscure tokens where there’s more price variability between exchanges.
The Bottom Line
Trading strategies are an excellent way to produce more consistent returns and take emotion out of the picture. But no single trading strategy is right for every person or market. You may need to experiment with different market strategies to see what works best for your risk tolerance, capital, time, knowledge, and skill level.
After you’ve developed a trading strategy, tracking your results to understand your performance and risk is essential. The same data can help compute your capital gain or loss and complete your yearly taxes. Fortunately, ZenLedger can help accomplish these goals without using complex spreadsheets or, worse, manually writing down transactions.
This material has been prepared for informational purposes only and should not be interpreted as professional advice. Please seek independent legal, financial, tax, or other advice specific to your particular situation.