Trading digital currencies offers significant potential for would-be investors, but this practice also carries significant risk. While there are countless guides online about trading these digital assets, traders can benefit from knowing what to avoid when it comes to navigating this new and volatile avenue.
1. Don't Get Swept Up By The Hype
For starters, traders should avoid getting caught up in the hype. The digital currency markets are driven largely by the sentiment of traders. Investors should remember that just because everyone jumps on a bandwagon, it may not be the greatest idea to follow that trend.
Digital currency markets experienced sharp gains in 2017, when their total market capitalisation rising from US$17.7 billion to US$603.7 billion. As a result, this broader market climbed more than 3,300% during the year.
When 2018 started out, these gains continued and the market value reached an all-time high of US$835.5 billion on 7 January.
These gains took place as the broader crypto markets experienced significant hype. For instance, general search interest for the term "Bitcoin" reached an all-time high between 17-23 December 2017. Alternatively, search interest for "crypto" reached its highest point between 7-13 January 2018.
Around this time, several market analysts pointed to the market's steadily growing visibility as a major cause of rising asset values. Digital currencies managed to draw significant attention, pushing prices higher and generating additional visibility.
This strong upward trend didn't last forever, and the broader digital currency market fell in to a sharp downward trend after that. It reached as low as US$276.1 billion on 6 February 2018 and as of 15 June 2018, the market fell roughly 67% from its all-time high.
Search interest in "Bitcoin" and "crypto" declined as well, with the former reaching a score of 44 on Google Trends during the week between 4-10 February 2018 and the latter registering 53 during that time.
While some investors who bought digital currency early on did well, those who bought at or close to the top suffered notable losses. An asset may have a lot of visibility, but that doesn't mean it's a good investment.
Traders can benefit from conducting thorough research on any potential investments while making sure that their decisions are grounded in facts and not hype. It's also important for traders to develop a plan and stick with it, instead of being swayed by their emotions. Many investors have become overly optimistic near the end of bull markets, causing asset values to become artificially inflated.
2. Don't Be Swayed By FUD
"FUD" is a term used to describe "fear, uncertainty and doubt." While digital currency certainly has its advocates, it also has its critics. Several prominent financial experts, including Warren Buffett and Jamie Dimon, have expressed their doubts about Bitcoin.
Buffett remarked that Bitcoin is not an investment. "If you buy something like Bitcoin or some cryptocurrency, you don't have anything that is producing anything," he said. "You're just hoping the next guy pays more."
Comments like these can move the markets. In fact, Bitcoin fell more than 10% after Dimon stated during a conference that it was a "fraud" that wouldn't "end well." While Buffett and Dimon are both well-known in the world of finance, their viewpoints should not be taken as gospel.
Once digital currency traders have developed a trading strategy, they can benefit significantly from maintaining that approach even when well-known market analysts provide less-than-optimistic commentary.
3. Don't Trade Using Risky Exchanges
One quick way for a trader to lose their money is to use an exchange that gets hacked.
Both Bitfinex and Mt. Gox have both suffered high-profile hacks, resulting in the loss of hundreds of millions' worth of digital currency.
An easy way to reduce risk significantly is to find exchanges that have not been hacked. Coinbase, for example, has never been hacked, at least not at the time of this writing (15 June 2018). However, this makes it one of very few exchanges that has not suffered this fate.
When conducting thorough research, investors can find exchanges that have built up a strong reputation, withstood the test of time and avoided getting hacked. Using an exchange like this for digital currency trading can make all the difference.
4. Don't Fall Victim To 'FOMO'
The digital currency markets are highly volatile. The trading activity surrounding individual digital assets can be very low, making it easier for large players or "whales" to cause notable price fluctuations.
When the markets push higher, digital currency traders may be tempted to "jump on the bandwagon" and buy a digital asset (or assets) in order to turn a profit. Once a digital currency has risen significantly, some investors may purchase the asset because they think it will keep rising and don't want to miss out. This phenomenon is called "Fear of Missing Out" or simply FOMO.
What goes up must come down, though, and sharp rallies frequently give way to notable declines. A perfect example of this is Ripple's XRP token, which rose more than 35,000% during 2017. In January 2018, it reached an all-time high of US$3.84, but then plunged significantly, falling below US$1 the following month.
Ripple climbed as the broader digital currency experienced a very strong rally, and many individual digital assets plunged following the start of 2018. In the coming months, digital currencies lost billions of dollars' worth of value, falling to a market capitalisation of roughly US$300 billion by mid-June 2018.
5. Don't Sell Based On Emotion
Once a trader has entered a position, he or she should exit that position based on whichever strategy they have in place. They should not, at any time, sell based on emotion. Digital currency markets are particularly volatile, so those who are interested in trading it will need to be able to keep their emotions under control.
If an investor holds a digital currency and that asset falls in value, they should be sure to evaluate the situation before selling the digital token. Just because an asset has fallen in value doesn't mean that its fundamentals have changed. If a digital currency loses value and its fundamentals remain intact, a trader may be better off simply holding instead of selling.
While digital currency trading carries significant potential for would-be investors, they can increase their chances of success significantly by avoiding certain behaviours.
While the broader industry can experience substantial hype, traders can benefit from steering clear of being swayed by such developments and keeping their emotions in check. Avoiding FOMO and being on the lookout for FUD are also important, and should be considered by traders interested in this new asset class.