Cryptocurrencies have come a long way in the past decade. At their peak, all cryptocurrencies were valued at over $3 trillion, making them a major asset class. By September 2023, these coins had a market cap of over $1 trillion.
There are also over 20,000 cryptocurrencies, with Bitcoin having a dominant position. In this article, we will look at the concept of day trading crypto and some of the top risks involved in the asset class.
How to day trade cryptocurrencies
There are several assets that you can focus on as a day trader. For example, there are assets like stocks, cryptocurrencies, bonds, commodities, and forex. Beneath these categories, there are thousands of assets that you can trade. In stocks, you can focus on technology, industrials, and real estate.
All these assets have their advantages and disadvantages. For example, many people opt for cryptocurrencies because of their volatility, huge variety of coins and tokens, and the fact that they are offered on a 24/7 basis.
Steps to follow
The first stage of trading cryptocurrencies is to find a good broker. Some of the most popular brokers are Coinbase, Binance, and OKX. In this, you should go with a broker with a strong reputation and lower costs.
Many other traditional brokers provide some crypto assets in their platforms. Some of the most notable ones are SoFi, Robinhood, and Schwab.
The second stage is to come up with a good trading strategy and test it well. Some of the top day trading strategies to consider are scalping, arbitrage, copy trading, trend-following, and reversals. Finally, you deposit funds and start trading.
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Crypto’s major caveats
Cryptocurrencies are still a relatively young asset class in the market. As a result, many countries are yet to come up with solid regulations in the industry. Therefore, crypto traders face the risk of using a broker or exchange that is not well-regulated.
Another risk is that many global exchanges secure their licenses in thinly regulated tax havens. Therefore, there is always a risk that a crypto exchange is a fraud or that it is not following the law.
A good example of this situation was FTX, which was the second most valuable exchange in the world. After its collapse in 2022, it was revealed that the company was doing illegal things like commingling funds and market manipulation.
The best way to solve this challenge is to do your due diligence and ensure that the exchange is well-regulated. In this, make sure that it is overseen by strict regulators like the SEC, ASIC, and the Finance Conduct Authority (FCA).
Liquidity is defined as the ease of converting an asset into cash. It can also be defined as the ease of buying a financial asset.
For example, in stocks, companies like Microsoft and Apple are always in high demand, making it easy to buy and sell them. Similarly, in forex, currency pairs like EUR/USD and GBP/USD are easy to do.
The crypto industry works in the same way. Some popular cryptocurrencies like Bitcoin, Ethereum, and Cardano tend to be highly liquid. However, most tokens are not liquid enough.
The best way to verify this is to look at the average daily volume of a token. You should then avoid tokens with a small amount of daily volume. Some of the best websites to look at the volume are CoinMarketCap and CoinGecko.
There are risks for trading low-liquid cryptocurrencies. For example, in many cases, they tend to have higher spreads and are easy to manipulate through pumps and dumps.
Many day traders thrive in high-volatile environments because of the huge market opportunities that emerge. In the past, cryptocurrencies were some of the most volatile assets in the market.
They are still highly volatile, especially when there is too much information to process. In some instances, many traders are caught up in situations when there is this volatility.
Another volatility risk is when cryptocurrencies enter a long period of no major movement. This situation mostly happens after these coins make major moves.
As a day trader, it is often difficult to make money when there is little volatility in the market. The rectangles in the chart below shows when it was difficult to make money trading Bitcoin.
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The other big risk when day trading cryptocurrencies is security. In the past decade, there have been many serious security breaches in the market. For example, Mt Gox was hacked in 2014 and over 850k Bitcoins were stolen. FTX collapsed in 2022, leading to over $8 billion in losses.
In 2016, Bitfinex was hacked and over 116k coins were stolen. Other security risks in the industry were the collapses of Quandriga CX, Celsius, and Voyager Digital. Many decentralized exchanges have also been hacked in the past decade.
Further, the crypto industry has many scams, which have been made possible by the rise of tokens. Tokens are cryptocurrencies that are created on top of an existing chain like Ethereum and BNB. Experts believe that most tokens that exist in the crypto industry are scams.
Other risks to consider in the crypto market are technical in nature. This is where a company’s technology is not up to standard and has numerous outages.
Some of the most popular technical risks that can lead to major losses are downturn of the exchange and glitches.
General risks in crypto trading
There are other risks that are common in the crypto market and other assets like stocks and currencies: high leverage, and diversification risks. A key challenge in crypto diversification is that most coins have a close correlation with each other.
As such, buying coins like Bitcoin, Ethereum, and Cardano will often lead to similar results. If the coins rise, you will have a big profit. On the other hand, if the coins drop, you will make substantial losses. In this case, opening similar trades will not give you the benefits of diversification.
How to reduce risks when day trading cryptocurrencies
There are several approaches to reduce risks when day trading cryptocurrencies. Some of the most popular strategies to do this are:
- Learn more about crypto trading – The first thing you need to do is to learn more about the industry. Fortunately, there are many platforms that have adequate crypto education content.
- Use reputable exchanges – Always use one of the top credible crypto exchanges in the market. Read reviews and ensure that they are well-regulated.
- Always use stops – Cryptocurrencies are highly volatile. As such, always ensure that you have a stop-loss and take-profit for all your trades.
- Manage your funds – Further, always use funds that you can afford to lose according to your risk-reward ratio.
- Position sizing and leverage – Many brokers provide leverage to their traders. Always use low leverage and small sizes to prevent excessive losses.
The crypto industry has become popular in the past few years. They have also made headlines for the wrong reasons, especially with the collapse of FTX and Celsius.
In this article, we have looked at some of the biggest risks to have in mind when trading and investing in digital currencies.
External useful resources
- Cryptocurrency Risks – State of Connecticut