If you’re new to crypto, in order to get off on the right foot as you start your trading journey, it’s important to learn and internalize some important trading principles.
There are probably a gazillion principles and “rules” to know for successful trading, each with its own nuances, but since this is a lesson for beginners, I’m just going to stick to what I think are the top 4:
- Know the market you’re trading.
- Markets are dynamic and don’t trade in a vacuum.
- Risk management is the foundation for successful trading.
- Psychology will have an influence on your trading performance.
An encyclopedia of information has been written on each principle, but given that this is a beginner’s guide to trading, I will restrain myself and only provide a high-level overview of each.
Let’s tackle each one individually…
1. Know the market you’re trading.
This may sound ridiculous to say because it’s such common sense, here I go:
Learn everything you can about the asset you’re going to risk your hard-earned money on.
Believe it or not, there are people out there who will throw their life savings at a meme stock or coin without doing ANY research. I mean NONE. ZERO. ZILCH.
They’ll do so because they saw it hyped up on social media, or their cousin who’s been into crypto for a solid three months said it was going to be the next big thing.
It seems obvious, but don’t blindly follow your cousin or anyone else on social media. Blindly following others means you know nothing about what the asset is about, how it works, and how it performs in different market conditions.
This also means you have no idea how to process new information on that asset or if market conditions change, likely leading to poor decisions when deploying and managing risk.
And besides that, following someone blindly opens up various other risks. For example, what if that same analyst/influencer/cousin does not follow up on their trade recommendation or disappears?
Or even worse, gives you misinformation on purpose to benefit their own position in some way.
That’s why the number one first step to trading or investing is to DYOR or “Do Your Own Research!”
Some of you may be thinking now, “But reading is hard! It takes too long! I’m used to watching 15-second long TikTok videos! I just wanna trade!”
Oh, fo sho reading is hard! And takes time!
But DYOR is what trading is all about! NOBODY is responsible for your trades but YOU!
So spend less time whining, and more time researching.
DYOR is applicable to all investments, but in the crypto space, it’s even more important given the lack of government regulation and investor protections on digital assets at the moment.
While crypto is seen by many as the future of finance, today….crypto is the digital Wild West!
To reduce some of the extremely risky (and shady) aspects of the crypto market, make sure any digital assets you’re looking to hold longer-term have a known and documented founding team, a history of hitting project development milestones, and if a trusted third-party has audited the code behind their project.
But remember, checking these boxes off doesn’t mean the project is protected against attacks or changes in regulations.
It’s a good idea to limit your exposure to each token to a small percentage of your portfolio, an idea I’ll touch more on later when I discuss risk management.
2. Markets are dynamic and don’t trade in a vacuum.
So you’ve done your research on a crypto project and now you’re ready to buy or sell your target coin or token. Your conviction is so high that after doing the work, you’re so excited about your trade idea that you can’t go to sleep.
Even though it’s the middle of the night, you just wanna trade right now!!
Whoooooooaaa! Slow down just a bit because there’s just a bit more research to do before jumping into a trade.
One of the biggest lessons that many traders learn with experience, and isn’t emphasized as much as it should be to beginners, is how exogenous factors often have a strong influence on an asset’s price action even though these factors seem unrelated and/or have nothing to do with crypto.
In other words, in many situations ahead, you’ll see a crypto’s price moving more with broader market themes or be affected by unexpected events outside of the specific crypto you’re following.
For example, what happens in the stock market can influence price action in the crypto market.
The most common example of this phenomenon is behavior caused by risk sentiment.
Risk-on vs. Risk-Off
Risk sentiment is a concept where financial assets generally fall into one of two main categories: a “risk-on” or a “risk-off” asset.
The current day’s broad risk sentiment may strongly influence the asset’s short-term price direction.
“Risk-on” assets are ones that typically attract buyers when broad market sentiment is positive. Asset classes that usually fall into this category are equities, commodities, and crypto.
“Risk-off” assets are ones that tend to attract buyers when the broad market is negative, or filled with fear. Asset classes that fall in this category are typically bonds, gold, and “safe haven” currencies like the U.S. dollar or Japanese yen.
Of course, this is a very generalized definition of both categories, and the assets that fall into each sometimes can shift depending on the major market themes and drivers. But more often than not, an asset’s behavior typically follows this dynamic, unless its own news is outshining that day’s major headlines and sentiment.
One of the most notable examples in recent history was the market’s behavior during the onset of the COVID-19 pandemic in the first quarter of 2020.
As the world witnessed the uncontrollable spread of COVID-19, and the actions by governments to try and contain the pandemic, traders began to price in expectations of a total global economic shutdown.
Most major asset classes sold off viciously over the course of a month, regardless of actual fundamentals.
In March 2020, with no specific headlines from the crypto space, bitcoin (BTC) fell over 60% from above $10,000 to below $4,000, while ether (ETH) fell nearly 70% from around $290 to $90.
And it wasn’t too long before we saw the other side of the risk behavior spectrum as market participants turned bullish on risk-on assets after a series of supportive actions were initiated by governments and central banks starting in April 2020.
Interest rates were cut by central banks to near zero in most countries, and governments flooded the system with liquidity and stimulus.
Combined with the eventual economic reopenings and new vaccines, buyers flooded back into risk assets, kicking off one of the greatest financial market rallies ever seen, including the start of bitcoin’s move to almost $69,000 in 2021.
But did any of this influence the Bitcoin network’s ability to securely process transactions or Ethereum’s ability to execute smart contracts? Nope. Almost every risk sentiment driver during those months was external to crypto fundamentals.
So as you can see, aside from having a view of your target crypto asset, you need to have a view of the world and monitor broad risk sentiment as well. Fortunately, this doesn’t require an advanced degree in economics or finance.
You can develop this skill or understanding through a study of global macroeconomic concepts in our School of Pipsology, and through your daily market observation practice. I’ll touch a bit more on that task in our example process framework discussion later.
3. Risk management is the foundation for successful trading.
So far, you’ve learned the need to DYOR token/project fundamentals, and you also know that you have to be aware of broad financial market conditions as well.
You’ve also probably figured out by now that even if you put in a lot of work to create a high conviction trade idea, the market could go sideways or against you very quickly for reasons that were unforeseeable and/or that you can’t control.
This brings us to, arguably, the most important skill for traders to master: risk and trade management.
Let me be more specific: Risk and trade management skills are just as, if not more important than market analysis skills, trade selection, and betting on the right direction.
Risk management is the process of identifying, analyzing, and taking action to reduce uncertainty and loss as much as possible.
Capital preservation should be the first priority of successful market speculation. And in order to preserve capital, you need to properly manage risk!
Without risk management, you won’t make it as a trader.
The key thing to understand, once again, is that unless you can see the future, no trade or investment can ever truly be risk-free. There will be some trades that lose and that is part of the game.
But if you put the work in you can significantly reduce your initial risk, or at the very least, you can limit your risk enough to where you can make rational decisions if the market hits you with something unexpected. I’ll touch on that more when I discuss trading psychology later.
And fortunately, if you develop solid trade management skills (making trade adjustments to reduce or increase exposure), you can create trade scenarios that not only limit your risk to near zero, but also create scenarios where the potential reward far outweighs your risk.
This is the reason why the best traders in the world don’t have to profit from every trade to build wealth over time. The best traders tend to cut their losers quickly, take some profits, and/or let their winners ride when it makes sense to do so!
In some cases, they may even have more losing trades than winners, and still, be net profitable.
For example, let’s say you take 10 trades with a $100 max risk on each, with a max potential of 3:1 return-on-risk.
If you win 4 trades with a 3:1 potential return-to-risk ratio (RRR) and lose 6 trades for a max loss of $100 on each (for a 40% win percentage), you still come out a net winner with a 20% return on all of your trades (or a portfolio worth $1200).
Now, imagine the volatility of crypto assets where markets have been known to rally 100% – 500% or more in a short amount of time!
Of course, it’s well documented that 60% – 90% drops are a NORMAL part of crypto history (along with a few 100% losses), which brings us back to why risk management is an even more important skill when taking exposure to crypto assets. Crypto price action is EXTREMELY VOLATILE!
So if you lose 90% of your money, don’t get angry at your computer. It’s not to blame for your poor risk management.
The key for every beginner is to protect capital and survive until you start becoming more competent in your newly found craft. Good trade and risk management skills can keep you in the game even when you’re off your game due to poor market analysis and bad trade idea selections.
Again, this is just an introduction to the world of trading, so I’ll end our discussion on risk and trade management here.
But when you’re ready, you can dive deeper by reading our lessons on risk management in our School of Pipsology. The concepts taught there are applicable to ALL markets, including crypto, and not just forex.
4. Psychology will influence your trading performance.
The fourth principle to understand and internalize about joining this world of trading is that your psychological state will be put to the test, and your ability to control your emotions will heavily influence your performance as a trader.
Obviously, when there’s an element of risk in what you’re doing, there’s going to be some level of anxiety or fear of loss, which can grow exponentially as losses occur.
This is absolutely true when engaged in the markets, something every noob learns even with a relatively small amount of capital at risk.
Fear could lead to irrational decisions like dumping a solid trade idea without giving it time to develop, or doubling down on risk to try to make back the losses. At this point, you’re pretty much just gambling.
On the other end of the psychological spectrum, being in the middle of a trade with massive reward potential or actually realizing an outsized reward could also likely lead to potentially damaging overconfidence.
Much like being overly fearful, overconfidence after a big win(s) could potentially lead to negative changes to one’s analysis or risk management processes.
One common example of this situation is when you leverage up a position and/or disregard a stop loss plan. These scenarios could result in you giving back a ton of your unrealized profits, or worse, blowing up an account to zero when the market quickly U-turns and goes way, way against you.
This is why the first three principles stated earlier are so important.
If you fully understand the crypto asset and the broad market conditions you’re trading, realize that markets can surprise you at any time, and have a solid risk management plan for various potential scenarios, you significantly reduce the odds of allowing your emotions to lead you to bad (and potentially catastrophic) trading decisions.
This is a very complicated subject to cover in a couple of paragraphs, but if there is one thing to remember before you start your journey it’s this:
Even in the best-case scenarios where you have a great trading strategy and a favorable market environment that leads to big gains, not controlling your emotions will harm your long-term performance.
So, do your homework, limit your risk on every trade, and don’t be overly attached to any trade idea. With experience AND practice, you’ll likely be able to keep your emotions in check.