Decentralized cryptographic currencies
A cryptocurrency is a peer-to-peer, decentralized, digital currency.
Cryptocurrencies were born having in mind the crucial and immutable goal of decentralization.
Decentralization means that there is no central authority to control the cryptocurrency, to confirm the transactions. The cryptocurrency's transactions are confirmed in a decentralized manner.
Cryptocurrencies, unlike traditional assets, are not owned by companies or governments, so while their creators can disappear, the software and the peer-to-peer network can continue to run, and can be maintained by others. Currently, there is some centralization in most cryptocurrencies; some of them have just a few miners, some have most of their consensus nodes owned by their creators, but things will decentralize more in time.
The vast majority of people probably get involved with cryptocurrencies in order to get rich, and believe that they invest money in companies which will bring them profit. While there are a lot of cryptocurrencies that are designed to work like that, the ones designed to be money are created by companies which want to jumpstart a decentralized platform (of protocols and software) in which anyone can participate to influence and strengthen it. The founding companies will, at some point, fade into the background, while the platforms will remain as infrastructure of this civilization.
Some states want to, and will, create their own cryptocurrencies. A state created cryptocurrency is not a cryptocurrency in the practical sense because it's controlled by one entity, the state, so it's in fact digital fiatcurrency owned by the state, not by the people. It's not decentralized currency, it's centralized.
Ignore any cryptocurrency whose creators don't make public the source code which runs the cryptocurrency.
For some cryptocurrencies the entire amount of available units is issued before the cryptocurrency is made public, but for some cryptocurrencies the units are created / mined in time (although some can be mined before the cryptocurrency is made public). In both cases, the software which runs the cryptocurrency can be modified by its issuer to issue more cryptocurrency later.
Most cryptocurrencies have a finite supply (= amount of available units), or have a very small inflation of the supply. Such cryptocurrencies can act as a store of value, like gold, meaning that they can preserve or increase their purchasing power over time; this means that in the future you will need to pay an equal or smaller number of units in order to buy the same thing; this is called "deflation of prices".
In contrast, a currency whose circulating supply increases in time, like fiatcurrency, has a decreasing purchasing power over time; this means that in the future you will need to pay a larger number of units in order to buy the same thing; this is called "inflation of prices".
Since the cryptocurrencies with the largest market capitalization have a fixed circulating supply, it means that their prices (relative to fiatcurrency) will increase in time, in the absence of bad news. This means that: future price = current price * future market capitalization / current market capitalization. This means that the value of the cryptocurrencies that you hold today will increase in time. Obviously, there is no guarantee that a specific cryptocurrency will survive for years or decades.
Since you can usually own and use fractions of a cryptocurrency's units, with many decimals, a high price per unit is not a problem.
In the first half of 2010, Bitcoin was worth less than 1 cent / unit. 7 years later it was worth over 1'000 USD / unit. This means an increase in price of over 100'000 times, so someone who has invested 10 USD in 2010 and kept it until 2017 became a millionaire. This kind of growth will never be achieved again, not even by far. This has happened because Bitcoin was the start of a financial revolution. As the market capitalization of a cryptocurrency raises, its potential percentual growth decreases because the total possible market capitalization is economically limited.
The World Economic Forum predicts that the market capitalization of the entire cryptocurrency industry could reach 8 trillions USD until 2027. The problem is that you don't know which cryptocurrencies will still have value then, nor which of them will grow faster than most of the others.
The level of decentralization is represented by the degree of difficulty that an organized group encounters in controlling the consensus, that is, the confirmation of transactions. Decentralization is not represented by the number of nodes from a cryptocurrency's network.
In order to quantify the degree of decentralization (D) in a practical way, we need an asymptote that depends on the number of entities that can collude in order to control the consensus. For example, for 1 entity we can have D = 0%, for 2 D = 5%, for 10 D = 50%, for 50 D = 90%, for 100 D = 99%, with the asymptotic limit of 100%.
An asymptote is used because the doubling of a low number of nodes (say from 5 to 10) has a much higher effect on decentralization than the doubling of a high number of nodes (say from 1000 to 2000), because it's much easier to seize control of 5 entities than of 1000.
If a single entity can control the consensus, the currency is not a decentralized cryptocurrency, but a centralized digital currency.
A cryptocurrency always uses a Decentralized Consensus Protocol for reaching consensus. The used technology is called Decentralized Consensus Technology.
Bitcoin is the cryptocurrency which has started the entire industry of cryptocurrencies. However, its Proof of Work consensus algorithm consumes huge amounts of energy, can perform only a handful of transactions per second and has large payment fees.
Alternative cryptocurrencies have emerged without Bitcoin's technical problems. These use other types of consensus algorithms, like Proof of Stake.
CoinMarketCap = Statistics for cryptocurrencies.
IcoStats = Statistics for cryptocurrency ICOs.
IcoDrops = List of upcoming cryptocurrency ICOs.
Bitcoin Magazine = News.
Coindesk = News.
Bittrex = Exchange.
Kraken = Exchange. Accepts fiatcurrency.
Keep most of your money off exchanges, for most of the time!
Warning: Many people believe that the cryptocurrency markets work like the stock markets. They want to believe that they invest in something that will make them rich. This is not the case. In the case of the cryptocurrencies designed to be money, there is no company in which you can invest. You can invest in software platforms which have no owner, that is, are decentralized. The software platforms have creators and developers, not owners. The creators and the developers can't help you with problems, like companies can do (or are legally obligated to do).
The most fundamental principle of investing, "buy low and sell high" / "buy the dips", passes through people's minds like a ghost through the real world: with no effect.
The vast majority of people buy high and sell low, that is, they start buying when they see the price raising, and start selling when they see the price dropping, the opposite of what they should do from a statistical point of view. The greater the raise, the more fiatcurrency they invest. Then, they complain that they are not making or are even losing money, and start searching for that magical recipe (= charts) that's going to quickly make them a lot of money, just like any other betting addict who believes that he's going to beat the "system" with his "method".
When a cryptocurrency's price raises, nobody (charts included) knows whether that trend will continue or the price will drop, so you have to follow a strategy which increases the potential profit and decreases the potential loss, balancing them, while still betting (rather than knowing) on a rise of the price in the long term.
You must count on a single guarantee: never, ever, never act as if you know what the price will do in the future, be it near or far.
Sadly, most people will continue to ask questions like "Is this a good time to buy?" Why is it sad? Because it's the wrong question to ask. If the answer were "yes", most people would use it as an excuse to invest a lot of money and then blame the person who has answered, for any drop of the price, even though the answer is correct in the context of a long-term investment.
It's also sad because if people ask someone with investing experience whether it's a good time to buy or not, and they are told that nobody can say what the price will do next, they will insist by asking "I understand that nobody can say what the price will do, but what is your opinion?" So, they ask for advice but ignore the actual advice and, since they only accept a "buy" or "don't buy" answer, they are trying to shift the blame for the aftereffect on someone else.
The purpose of a long term investment is to maintain, and possibly grow, the value of the investment over years or even decades.
Some people say that you should invest a lot of money when the price is low. The problem is that you can never know if a price will raise or drop after you start investing, so you have no idea what "low" is (relative to).
When the price drops dramatically, like half in a few days, when everybody panics and starts selling, in the absence of bad (or worse) news, treat this as a buying opportunity because the buyers are inclined to accept the higher prices easier in the future, since they were recently in that area.
The essence of a responsible investment strategy is:
Buying at the current price allows you to profit if the price keeps on raising, while buying during price dips decreases the possibility of using your entire investment budget to buy at what might be the highest price. Note that nothing protects your investment if the price trends toward 0.
Buying during price dips allows you to benefit from an average of the prices of each of your purchases.
Many people will not buy when the price decreases because they fear that it will continue to do so. But you have to ask yourself why would the price continue to decrease and not recover in the long term? Really bad news are a reason, fear is not.
Some people compare buying when the price decreases with catching a falling knife. This comparison is fundamentally flawed because the knife is drawn by the ever present gravitational force, but the price of a cryptocurrency bounces around, yet still has a general tendency to raise because the industry and the economy grow, unless there are long lasting bad news.
Even if you were to buy at the top every time, you could still make a profit, like in this example.
No matter how safe your investment strategy is supposed to be, you have to be prepared for severe recession periods when there will be months or years of prices that are much lower than those at which you have invested. If external circumstances force you to sell cryptocurrency during a recession, before the price recovers, you will have to be able to support the incurred losses. This is why you should never invest more money than what you can afford to lose.
Invest in several cryptocurrencies because nobody knows which of the current cryptocurrencies will still be around in a few years, or how much will each grow. Diversification lowers the potential losses and lets you profit from the growth of several cryptocurrencies.
How do you decide which cryptocurrency to buy? A cryptocurrency with a small market capitalization can grow percentually much more than one with a large market capitalization, but it can also disappear much easier. Never take a buy decision based on the price, on the number of units that you can buy, or on the total circulating number of units; they are irrelevant as indicators for potential growth.
A simplistic way of deciding what to buy is to use diversification, without any thought process. For example, you could invest a small part of your budget in every cryptocurrency which is in the top 25 by market capitalization. This would ensure that your profit (or loss) would move together with the vast majority of the industry.
If you want to get more involved in the industry, then look at the cryptocurrency's team, at its (real world) connections, at what problems it's trying to solve, at its potential technical performance, at the geopolitical context. Is the cryptocurrency an internationalized effort? Is the emerging cryptocurrency designed for a market in which an established cryptocurrency would have difficulties to enter? How does it compare to other cryptocurrencies which try to solve the same problems? Can it keep the pace of the competition? Why would it have a market capitalization similar with the competition?
Follow the industry news, but realize that the people with lots of money, the market movers, will find out the rumors and news before the vast majority of people, and will buy or sell before the rest, leaving the others to buy at the top or sell at the bottom. Then, they'll do the opposite (sell or buy) before the others realize what's happening, leaving everyone else trapped at a loss-producing price (if they were to sell then).
Don't waste your time and energy trying to predict, intuit or guess future prices. Money is made with statistics, not gut feelings. Gut feelings, greed and fear of missing out (price raises) ruin you in this business.
One of the worst mistakes you can make in trading is to believe that you, after a number of successful predictions (which are actually guesses), have an understanding of how the markets move. Nothing and nobody, be they charts, experts or gods, will save you from the huge mistake that will come at some point, and it will come because you believe that you "get it" now. What you don't get is that all patterns work until they don't, and when they don't, the losses will be large enough to wipe most of your profits (because you will hang in there believing that your pattern will save you, that it will work if you just give it a bit of time).
The fact that people know all these things won't help them. When the time to act comes, a fog of feelings will set set over their minds, and logic will desert them. People always find justifications about why they should buy a cryptocurrency whose price is raising. They'll tell themselves that this time will work because they feel it, that luck is on their side, that they're special people to whom bad things don't happen, that this has worked in the past, that they can see the trend, that this time there is good news, that they know that this cryptocurrency is not like the others and has a history of rebounding quicker than the rest, that this cryptocurrency is the next Bitcoin-like revolution, that this time they will score big to compensate for all the losses, and, finally, that they've heard (on the Internet) of people who do this and make a lot of money. The thoughts of a betting addict. And so, they just click their money away.
State regulation is not bad news. Some investors perceive state regulation to be bad, but in fact state regulation brings stability and predictability for big investors and for businesses. It's important to note that state regulation and banning are different things; regulation means the acceptance and the ordering of the business environment, banning means not accepting and forbidding business. When a rumor about impending state regulation (not banning) causes a dramatic drop of the price, as it usually does, treat that as a good opportunity to buy, but keep in mind that you don't know when the drop will stop.
Invest in emergent markets, if the business model seems sound, because the growth potential (in percents) is greater than in mature markets, and once an emergent market becomes mature, the investment value will have grown much more than it could have grown in a mature market.
For example a cryptocurrency with a market capitalization of 1 billion (at investment time) requires 99 more billions in order to grow your investment 100 times, however, a cryptocurrency with a market capitalization of 10 billions requires 990 more billions in order to grow your investment 100 times, and obviously, it's far easier for a cryptocurrency to grow with 99 billions than 990 billions. Of course, a small cryptocurrency is also riskier for investments since it could disappear easier than a large cryptocurrency, so you should invest only a small amount of fiatcurrency in one.
However, it's important to understand that the price doesn't depend on the amount of fiatcurrency which gets into the cryptocurrency, it depends on the direction in which sellers are willing to provide liquidity, and on the direction in which buyers are willing to consume the available liquidity. This is true for any market.
Liquidity is the ability to trade a large volume of cryptocurrency with very little change in its price. Simplistically, it can be calculated as V / (H / L - 1), where V - volume per period, H - period high, L - period low.
A market capitalization X USD doesn't mean that an amount of X USD has changed hands from trader to trader, in exchange for cryptocurrency, or that if everybody were to sell then they would be able to do so at the current price. It just means that the interest of the traders to provide and consume the available liquidity has driven the price to that level.
Some people say that cryptocurrencies are in a bubble, meaning that they are valued too high and the bubble will pop. Say this is true and the prices of all the cryptocurrencies drop to 10% of what they are now. What does that mean? It means that it's a buying opportunity because the buyers are inclined to accept the higher prices easier in the future, since they were recently in that area. Even if the price were to go to 0, so long as it goes back up, the value of your investment is preserved, except if you do margin / leveraged trading or you are manually using stop-losses. Why would the price recover? Because cryptocurrencies (unlike traditional assets) are not owned by companies, so while their creators can disappear, the software can continue to run and can be modified by others. In the absence of a fundamental cause that can bring cryptocurrencies to a 0 valuation, the prices should recover, even though it could take years.
The profits and losses, expressed in fiatcurrency, of a cryptocurrency are realized only when the cryptocurrency is sold in exchange for fiatcurrency. Until then, its value is like Schrödinger's cat, in multiple states at the same time. While the cryptocurrency is kept, its price could change dramatically during the next few days, weeks, months or years. This means that you should not despair when your investment's value is lower than originally, nor should you gloat when it's higher than originally.
While a drop of the price of a cryptocurrency A (that you own) decreases your investment's value, if you believe that the price of a cryptocurrency B will raise before the price of the cryptocurrency A raises, you can move your investment there without a loss. Even if you do sell, if you later buy back at the sell price then it's as if you haven't sold.
In metaphorical terms, if an elevator gets you down a few floors, you can take back up any other elevator, not necessarily the same. Still, you don't know in which direction any elevator goes, so randomly jumping from one to another might in fact bring you all the way down to the ground floor. In fact, you will most likely jump to a cryptocurrency which had a recent price raise, so you think it will continue to raise without limits, but that's a bad moment to jump to it.
If you start feeling like the market is a living organism that reads your mind and always makes large movements against you just before or after you act, it's because it's true. The market doesn't have anything personal against you, it's just that you are part of the vast majority of people who are predictable and are too slow to recognize a good opportunity and act on it on time. And if you recognize a good opportunity but are unprepared to act on it, the result is the same.
What should you do in such moments? Wait for the market to go through a drop-raise cycle. Why wait? Because nobody knows how long it would take for this to happen, so you shouldn't move to another cryptocurrency whose price you think might raise in the meantime.
Sell only when it's necessary, like when you want to buy a home, or if you want to recover your investment in fiatcurrency.
If you do sell, you don't have to sell everything. You could sell only half, and keep the other half invested because the price of the cryptocurrency might raise.
Selling a cryptocurrency increases the potential losses because the price could keep on raising, and if you were to later buy at a higher price, you would lose the difference between the sell and the buy, compared to what would have happened had you not sold.
Never do margin / leveraged trading; this is reserved for trading traditional assets, not for investments. The volatility is already high for cryptocurrencies.
Do you need stop-losses? If you invest on the long term, if you are sure that you can endure years of recession without selling cryptocurrency, if the cryptocurrency will still be around in years, so long as the price is going to continue to raise (because the industry grows), stop-losses are not mandatory.
Always use limit orders because these will be executed at the specified price or one which is more profitable for you. This is very important in a market with a limited liquidity, a market in which your orders may need a long time to be executed.
This article isn't a recommendation to start trading or investing!
Investing money is risky: you might lose all the invested money!
Never invest more money than what you can afford to lose!
This strategy is specifically designed for cryptocurrency markets, which are expected to grow over time and have a very high volatility, not for traditional markets (which may require margin / leveraged trading because their volatility is small, which may require a different approach).
This strategy considers that the cryptocurrency prices are expressed in fiatcurrency, prices which in the long term should be raising.
This strategy is just an example that you can build on. All the values specified here have to be adjusted to the real context, as often as necessary (since the cryptocurrency markets are very dynamic).
Create a pool of several cryptocurrencies that you could invest in.
The pool should include the cryptocurrencies that are available on the exchanges that you use, have a minimum market capitalization of 100 millions USD, have a minimum daily volume of 1 million USD, have public source code (for running the cryptocurrency), appear to have good growth potential, have solid teams, are not scams, and fulfill whatever other criteria you want.
Let P be the current price of a cryptocurrency.
Let H be the highest price of the cryptocurrency, from the past 2...6 months. When trying to determine H, exclude any spikes which appear to be technical anomalies, that is, which shoot out of the normal price range. These technical anomalies are short lived (usually minutes) and have very little traded volume.
Put all the fiatcurrency that you want to invest in a budget B. Every time you put money in B, split it in a budget BC and a budget BL. For example, split it 50% (BC) and 50% (BL). BC is for buying at the current price. BL is for buying during laddering.
Every time you receive your regular income, take a small part of it, like 5%, and put it in B.
Calculate a slice SC as a slice percentage S% (like 10%) from BC, so SC = BC * S%. You should recalculate SC if the maximum amount of fiatcurrency that you regularly put in B changes significantly.
Calculate a slice SL as a slice percentage S% (like 10%) from BL, so SL = BL * S%. You should recalculate SL if the maximum amount of fiatcurrency that you regularly put in B changes significantly.
A small value for S% reduces the potential losses (and potential profits). The "all or nothing" principle is a very risky approach that's used in betting, not in rational trading.
If you're aiming for higher potential profits, and you can handle the higher potential losses, you can significantly increase the slice percentage. The larger the percentage is, the fewer cryptocurrencies you can invest in at the same time.
If the price experiences a very large increase in a very short time frame (like a few days, or even weeks), increase which is called "parabolic raise", this will be followed by a correction which can easily put the price back at the level from which the parabolic raise has started, so don't get greedy in such moments, so don't increase the slice.
Calculate SCH = SC * P / H and SLH = SL * P / H; this means that the more the current price decreases relative to the recent high, the smaller the slice to use is. This is done in order to reduce the potential losses, and is optional.
For example, let's say that you buy with a slice SC at the price P1, and then the price drops to price P2 = P1 / 10. If the price has dropped so much, maybe it will go to 0 in the future. In that case, if you were to buy with an SC at price P1 and at price P2, you would lose 2 * SL. However, if you were to buy with SC at price P1, and with SC / 10 at price P2, you would lose only 1.1 * SC.
Buying at the current price
Since you don't know whether the price will move up or down in the future, you should buy at price P.
Buy several cryptocurrencies, each at its own price P, using a slice SCH for each. For the cryptocurrencies that you trust more, you can use several slices.
If you don't have enough money for a buy, you could sell a part of a cryptocurrency which has made a significant profit.
Buying the dip
You should regularly evaluate if you can buy a cryptocurrency from the pool with a significant discount relative to its recent high. In a way, this rewinds the time back into the past when the price was much smaller than its recent high. Hopefully, the price will then start raising because the buyers are inclined to accept the higher prices easier in the future, since they were recently in that area.
Buy a cryptocurrency whose price P is significantly below H, using a slice SLH. This technique is called buying the dip.
If you want to understand if the moment is potentially good to buy or sell a cryptocurrency, compare it with the other cryptocurrencies from the pool, and with their average. For each cryptocurrency from the pool calculate P / H, P / A, and H / A; A is the (exponential moving) average of the price of the cryptocurrency, for the period used to determine H.
Aside from H, another point of interest is the low after high (LaH). This shows how much the price has dipped after H.
If you want to be sure that you don't miss the buying opportunities created by price dips, set up notifications, via mail or SMS, for the desired prices.
If you set up a buy order in advance, at the dip price, the currency with which you set up the order becomes locked and unusable for other orders until you close the locking order.
While nobody can know whether the price will go up or down, on whatever timeframe, there are markets where it is believed that the price of assets will raise in the (very) long term because those industries will grow in time, and since the supply of assets remains fixed, the price will also rise. In such markets, laddering is a trading technique which can lower the risks, especially on medium term. Laddering is an extension of the "buying the dip" technique.
Laddering means to divide / multiply a reference price R with a multiplier M (number above 1) in order to create buy / sell prices that are the rungs of the ladder. As the current price drops and touches a rung, the trader must buy the cryptocurrency with a slice SLH of his budget. As the current price raises and touches a rung, the trader must sell a slice of the cryptocurrency; this step is only for traders, long term investors can ignore the selling part. The same rung is not used consecutively (= twice in a row), no matter the type of trade.
What should the reference price be? It's not important. It could be the H from when you've first started using this technique, or a strong support / resistance price from the past, or the last price at which you've bought / sold before using this technique, or the current price from when you've first started using this technique.
The trader has to optimally choose the multiplier M and the budget slice percentage S%, in order to have what to buy and sell at all times. For the trader to understand if the chosen values are a good choice, he should ask himself if the resulting increase of investment is worth the effort and risk.
Calculate the rungs of the ladder with G = R * M ^ X. M is the multiplier. X is an integer that is 0 at the reference price, goes more and more below 0 for each rung below the reference price, and goes more and more above 0 for each rung above the reference price.
Here is an example: the reference price is 64 and the multiplier is 2. The rungs then are (0, ..., 1, 2, 4, 8, 16, 32, 64, 128, 256, 512, …). If the price were to drop from 64 toward 32 and touch this, the trader would buy the cryptocurrency using a slice of fiatcurrency. If the price would then jiggle around 32, the trader would not do anything. If the price were to go back to 64, the trader would sell a slice of the cryptocurrency for fiatcurrency.
Here is a simple example of why it's important to budget, to buy as low as possible, and to still bet that the price will recover, at least in part, after a significant drop.
Let's say that cryptocurrency CC has a price of 10 USD. You use 500 USD to buy 50 CC.
The price drops to 1 USD, and you use 50 USD to buy again 50 CC. Now you have 100 CC for a total investment of 550 USD.
At this price, the value of your CC is 1 USD * 100 CC = 100 USD, so the current value of your investment is down to 100 USD / 550 USD = 18% from the total investment.
If the price goes to 0, you have lost 550 USD.
If the price increases to 5.5 USD, the value of your CC is 5.5 USD * 100 CC = 550 USD, so you've recovered your entire investment, even though the price is significantly lower than the original 10 USD.
If the price increases to 10 USD, the value of your CC is 10 USD * 100 CC = 1000 USD, so you have a profit of 450 USD, even though the price is the original 10 USD.
Traders always try to make a profit before others can, so trading is a giant poker game. This is why the future can't be predicted by the past.
Technical analysis can only describe what has happened in the past. When it's trying to predict the future, technical analysis is like astrology.
If technical analysis tells you that in the future the market will go up... unless it goes down, it's useless. To be useful, it must tell you only one of the following signals: wait, buy, or sell.
The price, the volume, the order book, the indicators, the overlays, they all show what was and what is, but never, ever, can they show what will be.
Technical analysis fits the patterns to the data, that is, it works for the past because the analyst changes the described pattern to fit the analyzed time frame.
Some people say "But look at how the price moves around the average, at how it bounces when it touches the Bollinger band, it obvious that TA works!" The average shows you what has happened, not what will happen; it contains only past information. In fact, the average moves through the price, not the other way around. Same for the Bollinger band. That's why the price is sometimes way off from the average, or outside the Bollinger band: because the TA indicators follow the price, not the other way around, so they can't predict the future, they only describe what has been (on average).
Some people say that TA works because everybody follows the same signals. If the majority of traders were to follow the same signals, then not enough traders would be left to take the opposite position; if someone buys then someone must sell, if someone sells then someone must buy. Since not enough traders would take the opposite position, the price would move against the majority by trying to find the requested liquidity. Therefore TA wouldn't work.
Not convinced? Then ask yourself, who makes money from trading? The majority of traders who follow the same signals, or the few experienced traders who are the first in what they do and take the opposite position? Also ask yourself, who is rich, the majority or the few? If the majority of people are not rich then why would you do the things that the majority does, why would you not change, why would you avoid doing what is needed to become at least as knowledgeable and experienced as the rich people? Why not? The answer is simple: because you are part the majority of people. Change!
Why does TA appears to work sometimes? Because the investor buys low and sells high, because the price may generally move in the expected direction (for example, up for long positions), because leverage may be used to amplify the profit obtained from basic algorithms, and because the investor uses tools which increase the probability to make profit. These tools are: money and risk management, industry-wide statistical comparisons, gathering and interpreting the rumors and news (even using machine learning), understanding the mass behavior of investors, and trading algorithm simulations.
There are lots of recognizable patterns on charts. The mass behavior of people creates patterns. The problem is that all these patterns are transformed continuously, that is, they are scaled, sheared and rotated in unpredictable ways. Recognizing them afterwards is utterly useless, and in fact it's dangerous because it makes you think that recognizing them is useful in making a profit. It's like seeing shapes in coffee grounds; sure, you can see shapes in coffee grounds, but they have absolutely no effect on the future.
For example, in technical analysis there is a pattern called "pole and pennant" which is supposed to predict that a significant change in price will follow. This pattern looks like a triangle with the base on the left side and a vertex on the right side. This triangle is the result of mass behavior, that is, it's the effect of a cause. A significant change in price does follow, but not because of a geometric shape on a chart.
The reason why this triangle appears on the chart is that, firstly, the price moves in cycles, meaning that significant changes (up or down) are followed by small changes (called "consolidation"), then followed by significant changes, and so on. Secondly, in a period of consolidation a lot of cryptocurrency is bought at continuously increasing prices (= with an upward slope) and sold at continuously decreasing prices (= with a downward slope) , with the buys and sells centered around the middle of the base of the triangle. Once the price flatlines and the triangle gets its right vertex, meaning that profit can no longer be made with small price changes, a significant price change follows (possibly only after a while). The direction of this change is determined by fundamental causes, not by geometric shapes, and this direction is the only thing that matters when trying to make a profit.
Trading can increase the potential profits (compared to investing), but at the same time increases the potential risks.
Trading is like a giant game of poker, that is, the participants try to make a profit in a zero-sum game. There is a slow increase of the total value of the markets which have a limited number of shares, because the economy increases in time, just not enough to matter for trading, only for very long term investing.
A trader must be very determined to succeed. You might think that you are too, but you are competing against the world's best traders, you are competing against organizations which get the news before they become public, and which simulate and execute their trading with farms of computers. How good are your chances? Some informal research says that, in the traditional markets, 1 in 30 (male) professional traders can make a profit that will keep them in the business for many years. That's 1 in 30 people who try trading professionally, not of all people, not of home traders! So maybe stick to investing? Still, trading can easily turn you into a millionaire... if you start out as a billionaire.
In the same time frame, it's most likely that you would make more fiatcurrency by simply holding your original investment in the cryptocurrency. Plus, you would not have to go through the effort and stress that trading requires, and you would not risk losing everything.
Here is an example of simulated trading during a ranging time frame, using EMAs crossover, for ETH-USD. The resulted budget is increased 1.22 times with no leverage, 1.30 with leverage 2, 1.26 with leverage 3 (less than for leverage 2), 0.34 time with leverage 4 (less than initially). During the same time frame the price rose 1.42 times, so trading (with any leverage) would have made a smaller profit. The crossovers are filtered by some parameters because the pure crossovers would bring virtually no profit. While shorting would bring a bit of profit during the down trends, they would add stop-losses during periods with little volatility. The simulation includes buy and sell fees, a decent amount of price slippage for positions sized to about 10% of the actually traded volume, and leverage with a 40% margin liquidation level. The simulation doesn't include income taxes, which would decrease the profit further.
When using EMAs crossover, leverage is good only during trending prices because it amplifies the potential profits (and losses), compared to investing. During ranging prices, leverage barely increases the final potential profit because the stop-losses are also amplified, but dramatically increases the potential risk of ruin. Due to the very high volatility of cryptocurrencies, leverage is much riskier than it is in the traditional markets.
If an algorithm makes less money than what buying and holding would make, the algorithm doesn't predict anything, it simply brute forces the market; if leverage is used, ignore the margin liquidation requirements during buying and holding. It can still make a profit, too small to make anyone rich, but not because it predicts anything, but because it forces the trading to follow the prices for a part of the movement. Such algorithms are useful for entities which are already rich because a small percentage from a lot of money is still a lot of money.
Trading requires the trader to "buy low and sell high". Don't interpret this as "buy the bottom, sell the top"; you don't need to know where either the bottom or the top are.
Beginners ask themselves what this means in practice, they ask how they can possibly know when the "market turns", that is, when the price stops decreasing and starts increasing. The answer is simple: you don't know, nobody knows. This is the wrong question to ask, a dangerous question which will keep you stuck in the belief that you have to know for sure.
The correct question is: how do you make a profit? Profit is not made with predictions since there is absolutely no way to predict the future price, it's made with a statistical advantage over a long time. To make a profit you don't need to know the exact movements of the price, you need the probability to be in your favor. The winning trades must bring more profit than the losing trades bring losses, so that they can cover the stop-losses, the exchange's fees, and the price slippage (because the available liquidity might not cover your orders, in their entirety, at precise prices).
You can use any algorithm which signals you to buy and sell, but, in order to make a significant, sustainable profit, the algorithm must be simulated with past data, and then used for the future in the hope that the future will be similar enough, even though not identical.
If you buy low and sell high, the amount of fiatcurrency you have is multiplied (compared to the original) with the sell price divided by the buy price.
Your ability to trade (and therefore increase your budget) is limited by the liquidity which is available during the execution of the orders, so don't image that you can trade millions with the same ease as thousands. The liquidity can be inferred (with good precision) from the volume.
If you want to make an order to buy / sell a significant percentage from the (short-term) traded volume, your order will get entirely filled only if you use a limit order which allows the price to move against you, beyond what you intended to use as a price. This allows more liquidity to become available for your order. This is called price slippage and eats a part of your potential profit. This means that beyond a certain amount of currency, the trading budget must be split among several orders and executed at different times, and even for different cryptocurrencies; even so, there still are limits.
A trade's closing price can be a combination of:
Making a profit from trading depends on the price going both down and up. It is however irrelevant when this happens, it's irrelevant if the price is trending up or down, it only matters if you find opportunities when you can buy low and sell high, no matter what the price is.
Here is an example. Let's say that you have an amount of fiatcurrency F1. You wait for the price to drop to half from the maximum price from the past 2 months. Then you buy. Then you wait for the price to double, and sell. At this point you have amount of fiatcurrency F2 = 2 * F1. After 3 such trades you have F4 = 8 * F1.
How do you chose your trading algorithm? You simulate each potential algorithm, with various parameters, on the past prices for the chosen cryptocurrency, whether manually or in software. The more detailed the simulation is, the higher the profit can be, and the smaller the risk can be. You only need to know the open, high, low and close prices of each candle. Also, the volume is useful to get an idea about how much you can trade during a candle.
It's best to simulate in software because once you implement your algorithm, you can instantly simulate it over any period of time, with any set of parameters, for any cryptocurrency. You can also continuously simulate the algorithm using new data, to see if the parameters have to be changed because the market has changed its structure. You can even implement an optimizer which finds the most profitable simulation; do keep in mind that you have to strive for repeatability, not profitability.
You must simulate your trading algorithm! There is absolutely no way around this. Slight variations can mean the difference between ruin and richness, and an algorithm which works for one cryptocurrency might not work for another. Any algorithm that works in simulations is a potentially profitable way to trade, but a simulation can only give you the optimal algorithm for the past. A simulation's result is no indication of what the used algorithm will do in the future.
If you find an algorithm which shows an enormous potential profit, you should not gloat. You have just overfitted the solution to the data, so the algorithm would not yield a similar profit on other time frames. You could, in theory, find an equation which describes every ebb and flow of the price, for a given time frame in the past, equation which shows an astronomic potential profit, but will the price movements be exactly repeated in the future? Absolutely not, so this equation will either bring zero profit in the future, or ruin you. The best algorithm is not the one which shows the highest potential profit, but the one with the most repeatable pattern (which you can't know in advance).
Once you simulate the algorithm on a specific time frame and get a good profit, simulate it on several other time frames which are close to the initial time frame; they have to be close because it's presumed that the market has the same characteristics for nearby time frames, but could have other characteristics for time frames which are farther in time.
A simple algorithm will better fit across multiple very different types of price movement, even though the profit will be modest. There will always be price drops followed by price raises, but the exact same ebbs and flows of the price will never be repeated. So, strive for repeatability, not profitability.
The shorter the trading time frame is, meaning the time between the opening and closing of an order, the faster and more reliable the Internet connection has to be. Retail traders should not try trading on time frames shorter than 15 minutes because they would be unable to compete with trading farms, and the resulting price slippage could lead to ruin.
Price movements are trend-based, not random. You might think that this is a good thing, that you need trends to make a profit, but random movements actually create more trading opportunities, and therefore increase the potential profits compared to the case of trend-based movements.
While artificial intelligence can be used to find profitable solutions which elude humans, it normally works when there is a target to find, that is, when it's possible to iteratively improve on potential solutions until an optimum solution is found. However, trading is a moving target, a target which tries to evade whoever or whatever attempts to catch it, a target which plays poker with its participants. Artificial intelligence works best when it has access to and can interpret news before they are released to the public.
Stop-losses are extremely expensive and can quickly decrease your budget to a fraction of the original one. For example, 3 stop-losses of 20% will bring your budget down to 50% from the original one; it's presumed that margin / leveraged trading isn't used.
Do you need stop-losses? If you were to do margin / leveraged trading, the stop-losses would be automatic. If you trade on short time frames, you need them; without them, you would periodically end up unable to trade for a long time, and unable to sell (for a profit) because the sell price would be well below the buy price.
To decrease the probability of losing your entire budget in stop-losses, you have to split your budget in several parts and only risk a single part in a trade, at any given time. For example, split your trading budget in 3 parts. If you have a 20% stop-loss (because the volatility is high) and you use no margin / leveraged, after 12 consecutive stop-losses (equally distributed among the budget parts) your budget becomes 40% of the original. The more careful you choose when to trade, the smaller is the probability for a stop-loss to occur.
To compensate for possible changes in the market behavior over the long term, you can use several different algorithms which yield a profit in simulations.
Trading in traditional markets is different than trading in cryptocurrencies because the volatility is much smaller. Because of this, traders have to use leverage, because of this they have to use stop-losses, because of this they can't invest using a buy-and-hold strategy, because of this they have to use trading algorithms which make a profit which is smaller than a buy-and-hold strategy (when ignoring the margin liquidation requirements).
Compounding (of profits) can make anyone rich, but it doesn't work. In order for it to work it would be necessary for the price to move in the direction that you expect.
Let's say that you simulate an algorithm which does well for the simulated time frame, and get a set of parameters. Compounding would work if you could get the same profit for all future time frames. But here is the catch: this doesn't work. If you were to extend the simulation to a much larger time frame, using the same parameters, you would see that the total profit is nowhere near the compounded profit.
The reality is that the algorithm parameters would yield the same profit only if the price would move in the same way. So, basically, all you need for compounding to work is a price which moves in the expected direction, which is equivalent to knowing the future.
Compounding would also work if you could successfully profit from jumping from cryptocurrency to cryptocurrency, just before the price of each is about to raise significantly, which is equivalent to knowing the future.
This doesn't mean that you can't make money from trading, but it means that you will not become rich from it.
Implementation details are far more important than what algorithm you use for entering / buying and exiting / selling, especially the details related to how you close the trade.
When you simulate a trading algorithm on past data, you have to be very careful about how you use the data from the moment of each simulated trading signal (which tells you to buy or sell).
The simulation algorithm has to iterate through all the candles, from the oldest to the newest, and for each candle (let's call it the reference candle) it has to go back a number of candles in order to gather the information required to compute the trading signals (which tell you to buy or sell during the reference candle).
A simulation will use the OHLCV (open, high, low, close, volume) of the candles. However because in real time trading the newest / current candle is being developed, its proper values (other than O) are unknown, so they can't be used until the candle is complete, which means that you can only buy and sell at the candle's closing price. It would be safe to use the values of the reference candle, but execute all the simulated buys and sells at the candle's closing price.
If a simulation shows a very high profit, it's most likely that you have used the values of the reference candle that you can't know during the reference candle.
A good implementation of an algorithm that uses a basic EMAs crossover, with no leverage, should yield a maximum profit (about) equal with what buying and holding would yield for the same time frame. This should hold true no matter how short or long the time frame is, so, compounding will not work.
Be pessimistic about your algorithm and presume that the buying price is going to be less favorable to you for most of the time.
It's best to display your trading signals on a chart, so that you can see how they all cluster, and how the losing trades cluster. If there is significant clustering, the repeatability of your algorithm is low, so you will likely not make money with it, and you might even lose money.
Leveraged trading allows you to amplify the potential profit and potential loss by a number, and is normally used in markets where the small volatility doesn't provide enough profit potential.
More interestingly, leveraged trading allows you to make a profit when the price of a cryptocurrency decreases, by short short selling the cryptocurrency.
Basically, when the price of the cryptocurrency is P1, you borrow (from the broker) cryptocurrency CC1 with which you buy fiatcurrency FC1 = CC1 * P1, hoping that the cryptocurrency's price will decrease.
The prices are expressed as P units of fiatcurrency for 1 unit of cryptocurrency ( fiatcurrency / cryptocurrency), written as BTCUSD (so the opposite of the division).
In order to get this loan, you need to reserve a collateral deposit (called margin) at the broker, in the shorted cryptocurrency CCOL = CC1 / L, where L is the leverage that you are using. L is an integer number, at least 2.
When the price of the cryptocurrency decreases to P2, where P2 < P1, you buy cryptocurrency CC2 = FC1 / P2 = CC1 * P1 / P2 with the fiatcurrency that you have obtained from the earlier sell (FC1).
However, you buy only enough to cover the loan from the broker, so only CC1 = FC2 / P2. This means that you only have to sell fiatcurrency FC2 = CC1 * P2.
The rest of the fiatcurrency is your profit FCP = FC1 - FC2 = CC1 * P1 - CC1 * P2 = CC1 * (P1 - P2) = CCOL * L * (P1 - P2).
Keep in mind that your margin must be able to cover, at all times, your loss, so CCOL * (1 - MLL) >= LOS. LOS = CC1 - FC1 / Px = CC1 - CC1 * P1 / Px = CC1 * (1 - P1 / Px), when Px >= P1.
This means that CCOL * (1 - MLL) >= CC1 * (1 - P1 / Px), so CCOL * (1 - MLL) >= CCOL * L * (1 - P1 / Px), so (1 - MLL) >= L * (1 - P1 / Px), so (1 - MLL) >= L * (Px - P1) / Px, so Px * (1 - MLL) / L >= Px - P1.
The broker will automatically close a short position if the cryptocurrency's price Px >= P1 / (1 - (1 - MLL) / L), when Px >= P1.
The broker will automatically close a long position if the cryptocurrency's price Px <= P1 / (1 + (1 - MLL) / L), when Px <= P1.
MLL is called margin liquidation level and it usually is around 0.4...0.5, but can be even 0.
Brokers automatically close a short position before its loss reaches the margin, in order to maximize the possibility to sell the fiatcurrency that you've bought, and buy the cryptocurrency that you've borrowed, ability which may be hindered by a limited liquidity when the price increases quickly.
If you want more information on this subject, search the Internet for "backtest trading software", "algorithmic trading software" or "algorithmic trading platform".
If you were to build your own simulation software, you would implement and know every detail of the simulation process, and you would be able to keep your algorithm private.
Quant Connect (integrates with GDax)