Trading is an operation where one party buys something from the other party in exchange for money. We do trading in our everyday life when we purchase foodstuff, clothes or even services.
This concept is also used for the financial markets where traders and investors buy and sell several types of assets and derivatives. Market participants purchase stocks i.e. for a lower price and wait until their cost rises to sell them. The more the price rises from the purchase level, the more profit you can get.
This is how it works in general. Nowadays almost everybody can open an account with a special company, named broker (or find a cryptocurrency exchange) and start trading. Blockchain innovations allowed users to start speculations on their own (without any intermediate) as traders are able to enter special exchanges and to place orders to gain money on the price difference.
We are going to cover such subjects as history, basics, principles, examples, pros and cons of trading in this introducing article.
History of trading
First exchanges were established in Europe in the XVI century. Their main goal was to provide merchants with marketplaces and the governments with the opportunity to place bonds. Trading with stocks and shares developed later as the response to growing commercial needs and companies’ expansion.
Such a notion as “trader” appeared first with the establishment of London Stock Exchange in the end of the XVII century.
Meanwhile, stock trading appeared in Asia one century later. Rice exchange in Japan started to operate in the XVII century. This period and geographical location are both interesting for traders as Japan is the home country for Munehisa Homma, who developed his famous Japanese candlestick method, allowing speculators to both read the price properly and to forecast future fluctuations.
Currency markets are younger. Forex appeared after the fall of the Bretton Woods system as European countries refused to support gold standard (a system, where currencies were linked directly to gold). Cryptocurrency trading emerged in the early 2010s when first exchanges started their activities.
Small retail traders and investors were enabled to start trading in the end of 1980s with the appearance of margin trading. In the early 1980s, some British dealing companies began to offer services to those individuals who had lower capitals. In 1986, most central banks accepted this trading mechanism and allowed almost unlimited opportunities for people to speculate and to invest in different types of financial assets.
What is the difference between trading and investing?
There is a big difference between those two notions. The main task of investors is to gain profits gradually, by purchasing and holding assets until their price growths. They also buy stock to get dividends.
Trading, on the other hand, involves more frequent buying and selling of assets as speculators aim to generate returns from the price difference.
There is one more thing to pay attention to. Investors have less performance than traders. The first group may be content with 10 percent of annual profit when the second group may have about 10 percent monthly.
Nowadays this line between traders and investors is almost invisible, especially within the cryptocurrency industry. Investors, there are long-term (or position) traders while traders are speculators holding their positions for hours or days.
Trading basics – supply and demand
The main idea of trading is to find an underrated asset, buy it and hold until its price rise in order to sell it later. It sounds obvious but here lies the main principle of trading. How do traders and investors know, when to purchase a currency pair or a stock and when to get rid of it?
There is a so-called supply and demand law. It explains the interaction between the supply of an asset and a demand for it. When those two aspects are misbalanced, the price goes upper or lower, depending on what is higher.
The cost of an asset will go upwards when demand grows. It means that more market participants want to buy it. And vice versa, when demand is weakening and supply becomes stronger, the price is likely to fall.
Let us give a simple example. Let’s say, a retailer has 10 apples to sell. There is only one buyer for them, who is ready to purchase apples for $5 per kilo. Will the buyer try to raise their cost? Definitely not as the demand is limited to one customer only.
Let’s make it a bit more difficult. We have 10 apple sellers and only four potential customers. The demand is lower than the supply in this case. Sellers will be forced to reduce prices as they have to literally fight for each customer. Those who hold their price at the initial level, have fewer chances to sell their apples than those who are ready to lower their costs.
However, in a couple of hours, the situation has changed as new customers came to the market and the ratio is currently the following: 20 customers/10 seller. There is a lack of apples and retailers can increase the price. Supply is lower than demand in this situation.
Main factors, influencing supply:
- Production capacity.
- Production costs.
- The number of competitors.
Factors, affecting demand:
- The number of substitutes.
- The cost of goods and services.
- Price changes for complementary products.
How does supply and demand work on financial markets?
Let’s have a look at the chart. We have drawn an ascending line which demonstrates how the balance between supply and demand changes. In the starting point of this red line, we have higher demand and lower supply.
Then the price goes upwards along the red line and both demand and supply become balanced. At some point, demand becomes lower and supply is higher. When this happens, the price reverses and starts to decline. This is how it works for financial markets.
Three main trading principles
There are several principles for traders to follow in order to succeed. We are going to mention three main aspects that are necessary for every successful currency and stocks speculators.
Buy lows and sell highs
This principle is based mainly on the cyclic nature of market fluctuations. If you look at any asset’s chart (including cryptocurrencies), you will see that their price has periods of decline and growth. If a currency is cheap currently, it is likely to increase its price in future and vice versa, if a currency is expensive at any moment, the price is likely to decline.
This aspect is very important for every trader as those who know where to buy and to sell are more successful than those, who place orders randomly. Traders who stick to this principle of trading, have higher chances to win.
This may sound obvious, but many beginners buy highs and sell lows as they have no idea how to find entry points properly. Those traders suffer losses and then start to learn something about trading. Those who pay significant attention to theory, have chances to become skilled investors.
Follow the market
This recommendation means a speculator has to always look for tendencies and follow them. If there is an uptrend, a trader is better to purchase an asset. In cases when the price goes downwards, investors are advised to get rid of it.
There is a proverb “Trend is your friend” meaning those who have found a tendency, have better chances to take profits. Trading against the trend is also possible, but these strategies are complicated and require more skills and experience.
Manage risks properly
The main reason for managing risks is the random result of every single trade. There is no a single strategy guarantying trader positive results in every position. Risks accompany investors during their market operations. Moreover, no one is able to reduce risks to zero levels. However, traders who manage them properly may minimize them.
What does it mean “to manage risks”? This includes calculations of eventual profits and losses that a trader can take and afford. Many cryptocurrency exchanges offer to their clients several tools to manage their risks by placing stop losses and even take profits.
Let us give you a clear example of the importance of risk management. A trader has bought one bitcoin for $9,000. The price declined to $6,000 and he decides to sell it. Trader’s losses were $3,000. Another trader has bought Bitcoin for $9,000 and placed a stop loss at $8,500. The price declined to $6,000, but this time stop losses triggered when the price reached $8,500. Trader’s losses were $500 only.
This is a simple but clear example of importance of proper risk management. There are several methods of how to do it and we are going to demonstrate them in our following articles.
Examples of trading
Here we are going to demonstrate you chart example of trading.
This example is about long position. It means a trader thinks that the price of XRP/USD is at its lows and the situation looks promising for buyers. What is the best decision here? Naturally, to follow the market. It means to purchase XMR/USD somewhere here. Let’s suppose this trader buys the currency pair at 0.5067. He holds his positions until the price reaches the second point and sells XMR/USD when the price reaches 0.7078.
The profit is 0.2011 pips (the smallest price change unit on financial markets). To make it easier to understand, if a trader has bought 100 Ripple coins at 0.5067, he would have an opportunity to earn $200. For each XMR, trader gains 20 cents of profit.
Looks pretty easy, but this is just an example. When traders look at price history, they always know where to purchase or to get rid of an asset. However, when they start real trading, it is not so easy to forecast future fluctuations. Professionals use different analysis methods to predict quotes. We are going to cover all of them in our following articles.
Pros and Cons of trading
The main advantages of this activity are:
- This profession is always in demand. Successful traders may earn money on their own or to become a part of cryptocurrency hedge funds, for example. The amount of those financial institutions increase every year meaning skilled traders have more opportunities to find a well-paid job.
- Trading offers an opportunity to start a business for yourself. There are no bosses, no orders, no tasks, no salary (except when you are working for a hedge fund or a bank, i.e.). You take all your profits (paying commission and other costs).
- This is an intellectual profession. Everything depends on how a trader controls himself, manages risks, reads the market situation. Professional traders see their accounts grow.
- Unlimited profits. When a person goes to a part or a full-time job, he has a fixed salary (or percent from company’s earnings, which is usually low). Those who trade, have the opportunity to gain more in case they are right. Those who had 100 BTC in 2009-2015, for example, became millionaires as the price reached $20,000 level and then declined towards $8,000-$9,000 in 2017-2018.
- Trading gives new knowledge and skills.
- No need to go to the office. Traders can place orders from everywhere if there is Internet connection there. Speculators use PCs, notebooks, mobile devices as a modern trading terminal are cross-platform.
- Low entrance requirements. Many brokers, as well as cryptocurrency exchanges, have no minimum deposit level. This means almost everybody can try trading.
As for the disadvantages, they are the following:
- Risks. They accompany every market position. Trader risks to lose a part of his investments or all money he deposits.
- High responsibility. Trading is not for lazy people. A speculator always has to be on guard, look for information, learn new tactics and strategies, analysis methods and so on.
- Trading is stressful. Speculators have to monitor their mind and physical health. Trading is stress and you need to learn how to decrease it.
Cryptocurrency trading features
Cryptocurrency trading is similar to other industries like Forex or stocks. Here are some features of this kind of investing:
- There are no brokers or dealers. Crypto traders go to special online exchanges where they can buy and sell coins.
- Cryptocurrency trading is available 24/7 as compared to Forex and stocks.
- The liquidity is lower. This leads to higher volatility and gaps.
- Lower volumes especially for exotic coins. This may result in pump & dump strategies.
- There are no tools like economic calendar or companies’ reports meaning the fundamental analysis of cryptos is harder to conduct.
- Hard to establish correlation between the coins. Forex and stocks traders always use correlation to predict prices and to hedge their risks. Correlation means different assets move in the same direction. In crypto market it is impossible to find correlations as there is no connection between different coins.
- There are no liquidity providers. When you trade on Forex, you deal with the liquidity providers – huge banks and market makers. In cryptocurrency industry, all trades are executed within exchange.
Trading offers many opportunities for investors and speculators. However, this is not just a simple road with no obstacles. In order to afford it, you need to learn, get experience and appropriate skills.