Over the past year, the public attention on cryptocurrencies like Bitcoin has brought a diverse range of people together in one sector: everyone from technology enthusiasts to financial institutions is trying to understand what the future of crypto will look like and how they can profit from it.
That’s gotten a lot of people interested in trading for the first time. If you don’t have experience buying and selling something like securities, trying to trade crypto can feel like learning to swim in the deep end of a pool. That’s why we’ve created this glossary of foundational trading concepts to help you get oriented as you start buying and selling Bitcoin, Ether, and more.
An exchange is a marketplace where people are able to buy and sell assets. The New York Stock Exchange (NYSE), for example, is a place where people are able to buy and sell stocks. There are a number of cryptocurrency exchanges set up today and that number is increasing all the time. Some of the major exchanges include:
Kraken, headquartered in San Fransisco, CA
Gemini, headquartered in New York, NY
Bitstamp, headquartered in Luxembourg
Bitfinex, headquartered in Hong Kong
itBit, headquartered in New York, NY
All cryptocurrency exchanges are not created equal. Different exchanges let you buy and sell different cryptocurrencies; different exchanges set different prices for their listed cryptocurrencies; and different exchanges have different volumes of trades happening on them, which changes how easy it is to buy or sell cryptocurrency efficiently.
The bid price for a given asset is the maximum price that someone is willing to pay for that asset. You can think of this as the “demand” side of “supply and demand.”
The ask price for a given asset is the minimum price for which someone is willing to sell that asset. You can think of this as the “demand” side of “supply and demand.”
The bid-ask spread is the difference between the bid price and ask price for a given asset. This spread is the profit that market makers earn by buying and selling the asset on behalf of investors. As an asset’s liquidity increases, this spread decreases correspondingly.
Volatility is the extent of changes in an asset’s value over time. If an asset’s value frequently fluctuates to a great degree — that is, if it’s highly volatile — then it’s typically thought to be a proportionately high-risk investment. The historically high volatility of Bitcoin is one of the reasons why some have been skeptical of Bitcoin’s capacity to act as a store of value. Volatility is also what gives traders the opportunity to profit through day trading and swing trading (see below).
When it comes to managing your cryptocurrency holdings, it’s important to understand who actually has your holdings. If you have your holdings in a wallet — whether that’s a hardware wallet, a software wallet, or a paper wallet — you control your private key and actually have custody over those holdings. On the other hand, when you buy and hold cryptocurrencies on most exchanges, they store those holdings in wallets of their own. That’s why some people worry about centralized cryptocurrency exchanges: if they’re hacked, their investors’ money could vanish overnight.
Fear of missing out (“FOMO”) is modern slang for a timeless, irrational behavior: worrying that you’re missing out on a great opportunity and therefore jumping into an investment. In the cryptocurrency space, otherwise inexplicable influxes of buyers have been attributed to FOMO.
Fear, uncertainty, and doubt (“FUD”) is modern slang for the “opposite” of FOMO: irrationally worrying that a particular investment or sector might collapse. In the cryptocurrency space, otherwise inexplicable sell-offs have been attributed to FUD.
The term “HODL” comes from when Bitcoin forum user GameKyuubi drunkenly misspelled that he was holding Bitcoin in December of 2013, despite its price crashing. HODL has become synonymous with the “trading” philosophy of buying Bitcoin (or other cryptocurrencies) and holding it indefinitely. The rationale behind this philosophy varies. Many who are entering the space with little trading experience believe that they will make more money in the long run by holding than they would by trying to catch the highs and lows of the market. Others — true Bitcoin maximalists, for example — believe that cryptocurrencies will ultimately replace fiat currencies, in which case it would be irrational to sell any cryptocurrency for fiat.
Dollar-cost averaging is the strategy of buying a particular dollar amount of an asset on a regular schedule, e.g., X amount every hour or X amount every day. The idea behind this strategy, which plays well with HODLing, is to gradually take on a position in an asset like Bitcoin in a way that resists the short-term swings of the market.
Generally speaking, diversification is a method of managing the overall level of risk in your portfolio by investing in a range of assets that aren’t perfectly correlated with each other, securing better profits (on average), and minimizing the risk of losses. It can be hard to diversify within the crypto sector at this early stage of its existence, but there are a few rules of thumb that are good to follow:
Use Bitcoin as the foundation of your crypto holdings. As the cryptocurrency with the biggest market cap, Bitcoin is almost like an index fund for the crypto sector: if crypto as a whole succeeds, then Bitcoin will succeed.
Holding Ether is a good way of betting that blockchain will have applications beyond being a mere store of value, since most other use cases are being built on Ethereum in one way or another.
Holding Bitcoin Cash is a good way of investing in the use of cryptocurrencies in commerce.
Arbitrage is the strategy of profiting by simultaneously buying and selling an asset in order to take advantage of market inefficiencies by the same asset being priced differently in different places. Especially in this early stage of cryptocurrency’s history, where liquidity varies widely from one exchange to the next, there are numerous opportunities to exploit pricing differences between exchanges to profit through arbitrage.
Swing trading is the strategy of buying an asset at a low price and selling it at a high price at a relatively high frequency — typically once a day or once every few days. The high volatility of many cryptocurrencies has led many traders to focus on this kind of strategy, though that high volatility can also make the strategy costly if you time your trades poorly.
Day trading is like swing trading but with a higher trade frequency. As the name suggests, day traders trade multiple times per day, typically trying to routinely profit from small fluctuations in a market.
Margin trading is the practice of buying an asset using funds borrowed from a broker. This is a risky method of trading because, if the assets end up decreasing in value, the trader can be left in significant debt — it’s possible to lose more money than one initially invested.
Leverage is the additional buying power created by margin trading, allowing you to effectively pay less than full price for an asset using borrowed funds. Leverage is typically represented as a ratio: for example, if you have $10,000 in a trading account and borrow another $10,000, then you have 2:1 leverage.
Types of trades
A market order is what happens when you make an agreement with an exchange to buy or sell a certain amount of an asset immediately at the best available price. Depending on the size of your order and the trading volume on the exchange, this can end up giving you an extremely suboptimal price, though it allows you to execute your trade quickly.
A limit order is an agreement that you make with an exchange to execute a trade only at a certain price point or better. If that price point ends up never being reached, your order may never be executed. Limit orders also allow you to set a time limit on the order, after which the trade won’t be executed at all.
A stop-loss order is a trade that you put in place for an exchange to immediately execute if an asset reaches a particular price point. As the name suggests, this kind of order is designed to limit your losses: if you’re invested in Bitcoin and want to make sure you don’t lose too much money in the event of it tanking, you can make a stop-loss order to ensure that your Bitcoin will be sold immediately if the price dips below a certain point.
A take-profit order is the “other half” of a stop-loss order: whereas a stop-loss order is put in place to limit one’s losses, a take-profit order is put in place to secure one’s profits. When this kind of limit order is put in place with an exchange, you will automatically sell the asset in question, immediately, if its value reaches a certain price.
Over-the-counter (‘OTC’) trades are how many high-net-worth individuals and institutional investors make their especially large trades: they use a broker who directly connects them with an entity willing to buy or sell the asset in question at a particular price. This is intended to avoid losing money by executing a trade so large that it moves the market — but the peculiar information asymmetries involved in such a trade make it easy to make a mistake that ends up offsetting the potential advantages of OTC trading.
Gorilla trades are an SFOX trade algorithm designed for executing large trades without inadvertently moving the market. This method of trade finds the best way to execute a large order by only showing smaller pieces of it on the order book, preventing it from getting buried deep in the order book. It’s best used when there are medium levels of activity in the market.
Polar bear trades
Polar bear trades are an SFOX trade algorithm designed to optimize the price on large orders. It is a hidden order that automatically trades on the top of an order book once a set limit price is reached. It’s best used with thin spreads and small quantities on the top of the order book.
Sniper trades are an SFOX trade algorithm, a hidden order optimized for speed. This algorithm is ideal for getting the best possible price on a large order quickly, as you would want to do when the markets are especially volatile and you’re worried about prices dropping drastically.
Time-weighted average price (‘TWAP’) trades are an SFOX trade algorithms and are like a more sophisticated method of dollar-cost averaging. These trades allow you to specify n, t, and p such that you buy or sell n of a cryptocurrency over t hours for an average price of p.
It’s easy to get sucked into the hype of cryptocurrency and dive into trading without a solid understanding of what you’re really doing. That way lies madness: if you’re shooting in the dark, any bulls-eyes you hit will be rare and purely accidental.
Take the crypto craze as an opportunity to learn about the concepts and strategies that underpin sound investing. Armed with more knowledge, you’ll be able to take advantage of the opportunities in this new sector without taking on outsized risk.
The above references an opinion and is for informational purposes only. It is not intended as and does not constitute investment advice,
About the author
Akbar Thobhani is the CEO of SFOX — a broker-dealer for institutional cryptocurrency trading. He started his career as a software engineer at JPL / NASA, and began mining bitcoins while attending MIT. Akbar was head of growth and business development at Airbnb. Specializing in trading and payments platforms, he has developed solutions for ITG, Boku, and Stamps.com.
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