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Trading on exchanges
In the previous chapters, we looked at how to start trading, set up your first wallet, and create a crypto portfolio. We’ve covered the trading basics.
Now, let’s learn more about advanced trading on exchanges, the best tactics, and things to avoid like the plague.
In this chapter, we will cover:
- principles of exchanges
- reasons behind market volatility
- how to carry out technical analysis
- techniques to analyze the performance of an asset or a trading pair
An exchange is a marketplace to buy, sell, and trade assets. These assets include cryptocurrencies, stocks, bonds, and foreign currencies.
The first exchanges appeared in the 16th and 17th centuries in Europe. The New York Stock Exchange (NYSE) and the London Stock Exchange (LSE) were established in 1792 and 1802, respectively. They may have developed over the years, but at their core, their principles have remained the same, particularly the principle of supply and demand.
Regardless of what we’re trading, supply and demand exist in all sectors, setting the price of the selected asset.
Let’s take a pair of sneakers as an example.
If we have a pair of just ordinary Nike sneakers with a large supply, the price will probably be something around $100. If we take a less famous brand with a similar supply but much less demand, then the price will be much lower, probably around $50.
If this same cheaper brand releases limited edition sneakers, then the price will likely increase but only by a bit. But if Nike releases a pair of limited edition trainers, then the price could be anywhere from $150 to $10,000, depending on the shoes and how rare they are.
The same situation applies to cryptocurrencies, too.
The average price is determined by
- how much the buyer wants to spend on the cryptocurrency and
- how much the seller is willing to sell it for.
The exchange tracks the flow of supply and demand for each crypto. They map these price changes out on technical charts. We can use these charts and graphs in technical analysis to examine the history of the chosen crypto and predict its future behavior. Will it rise or fall? Technical analysis helps traders decide whether to buy, sell, or hodl.
Candlestick charts
Regardless of what market you are trading in, candlestick charts are one of the key charts you will use. They are extremely useful in crypto trading. The patterns can show bullish and bearish trends and reversals in the market.
Candlesticks as a group are known as candlestick patterns. They use raw price data and are updated as soon as the trading period is completed.
Instead of a lagging indicator, candlestick patterns can be a leading indicator, so once you learn how to read candlestick patterns, you’ll be able to get ahead of the crowd and act based on the indicators before everyone else. It will be a great skill for your trading arsenal.
A 4-hour BTC/USDT candlestick chart
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A candlestick chart is a method of illustrating the historical price of an asset over a defined period of time. It gives a good summary of price behavior.
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| Fun fact: Even though candlesticks are a popular tool in modern trading technical analysis, they actually originated in 18th-century Japan as a tool for rice trading. |
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A leading indicator attempts to predict where the price is headed. A lagging indicator offers a report of conditions that resulted in the price being where it currently is.
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Every candle uses 2 physical features to display the 4 main components:
- The first feature is the “body” — namely, a wide midsection of the candlestick. It illustrates the opening and closing prices during the chosen time period.
- The “close” represents the closing price. It’s located at the top of the body if the candle is green or at the bottom if it is red.
- The “open” shows the opening price and is situated at the bottom of the green candle or at the top of the red candle.
- The final two components are the “high” and the “low,” which are illustrated by the second physical feature, known as the “wick.” The wicks are portrayed by thin lines extending above and below the body. The highest and lowest points of each respective wick represent the highest and lowest prices during the given timeframe.
A green (bullish) candlestick and a red (bearish) candlestick
Market sentiment
The candlestick can easily change through the trading cycle. On Changelly PRO, you can select timeframes from one minute all the way up to one month.
Given the volatility of the crypto market and the fact that it never sleeps, shorter timeframes, like 5 or 15 minutes, are quite useful, especially for short-term traders.
Long-term traders observe candlesticks with time periods of 1 day, 1 week, or even 1 month.
Candlesticks are usually displayed in one of two colors, green or red. A green candle is a buyer/bullish candle, illustrating that the price closed higher than it had opened. A red candle is known as a seller/bearish candle, representing that the price closed lower than it had opened.
The colors help traders quickly view and determine market sentiment and get an overall idea of price movements during the chosen timeframe.
For example, if a 1-hour candlestick opens at a price of $8 and jumps to $12 after 30 minutes, the shape of the candle will drastically change. Traders also noticed that the same candlestick shapes occur at the same stage of the price trend, regardless of the asset.
Identifying such formations and trends can be very lucrative. They can provide clues as to when a trend might reverse, hit its peak/lowest point, or just maintain its current trajectory.
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Market sentiment (investor sentiment) is the overall attitude of investors toward a particular asset. It is the feeling — or the tone — of the market, the crowd psychology revealed through the activity and price movement of the asset traded. Rising prices show bullish market sentiment, whereas falling prices show bearish market sentiment.
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Common single candle patterns
Reading candlestick patterns is a vital skill for all crypto traders.
Let’s take a look at some basic and common patterns. We’ll discuss more complex and intricate patterns later on in Chapter 11.
Depending on whether an asset is trending upward or downward, the candlestick pattern becomes bullish or bearish, respectively. We need a minimum of two candles to have a pattern and a relationship to analyze, but having more candles gives us a clearer and more detailed view of the market.
The first pair of patterns we’ll look at are bullish and bearish engulfing patterns.
Bearish and bullish engulfing patterns
Engulfing patterns represent a change in the market trend.
A bullish engulfing pattern would show a change from a downward trend to an upward trend. Let’s take an example of two monthly candles illustrating June and July to describe what it looks like.
In June, we had a small bearish candle; in July, we had a much larger bullish candle. The closing price of the July candle is much higher than the opening of the June candle. This means the market sentiment has changed, moving to an upward trend. For a bearish engulfing candle, the opposite is true.
Let’s take another two months, September and October. After an upward trend that lasted for a few months, in September, the closing price was closer to the opening price than it had been in the previous months, resulting in a smaller green candle. In October, the price dropped significantly, with the opening price now being much higher than the closing one. Here, the October red candle is much larger than the September green candle. This illustrates the change in the market to a bearish trend.
Another popular candlestick pattern is the “doji” candlestick.
It’s a neutral pattern that represents that the opening and closing prices are very close. Typically, it is the result of an indecisive market.
Doji candles have little to no body because the opening and closing prices are the same and often suggest a trend reversal. There are three main types of doji candles:
- A gravestone doji has a short lower wick and a long upper wick. This is a bearish reversal pattern, suggesting that there will be a reversal followed by a downward trend.
A gravestone doji candlestick
- A long-legged doji consists of long upper and lower wicks, with the thin body being almost central, looking almost like a cross. This pattern shows indecision and is most significant after a strong surge or drop. It signifies that a reversal may occur soon.
A long-legged doji candlestick
- A dragonfly doji is the opposite of a gravestone doji and basically looks like the letter “T.” It has a long lower wick, a short body, and a small upper wick. It can appear after either an upward trend or a downward trend. When it emerges after a rise in price, it can be seen as a warning of a potential price drop. If it surfaces after a drop, it can imply a potential increase in price. Traders usually wait for the next candle to confirm the market trend before acting on a dragonfly doji.
A dragonfly doji candlestick
| Fun fact: Doji candles got their name from the Japanese word for error. Presumably, this occurred because it was uncommon for opening and closing prices to be in (almost) exactly the same place in 18th-century rice trading. |
Another set of candlestick patterns is “hammers” and “hanging men.” These patterns are also known as “umbrellas.” They look like one since they have a distinctively long bottom wick. A red umbrella is known as a hammer. When you see a hammer, it often means that the asset is receiving some serious buy action and that the price may soon be on its way up. Green umbrellas, or hanging men, signify that people may be ready to cash out and start selling, reversing the cycle.
A “hanging man” candlestick
A “hammer” candlestick
Contrarian investing
Market sentiment isn’t always just based on facts and fundamentals. Many other human factors, such as emotions, crowd psychology, personal attitude, and fear of missing out (FOMO), influence the asset’s price and performance.
Investors, particularly new investors, often follow crowds and trends and buy or sell based on market direction. Fear, greed, and hype sometimes lead to assets being over/underpriced. This happens because markets can be subject to herd behavior. That’s why it is important to stay rational and avoid getting too involved emotionally.
Sometimes even trading against the market direction — going against the general prevailing consensus — can be useful.
This kind of investment strategy is known as contrarian investing.
Contrarian investors attempt to get ahead of the market and predict when reversals will happen before anyone else notices.
This strategy can be rewarding. Nonetheless, it is risky and takes a long time to pay off. Usually, it doesn’t just work the first time and often requires a lot of trial and error at the beginning.
One of the most famous contrarian investors is Warren Buffett. On contrarian investing, he famously said, “Be fearful when others are greedy, and greedy when others are fearful.”
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Contrarian investing involves going against market trends, selling when most investors are buying, and buying when others are selling. ________________________________________________________________________
Depth of market / Order book
Understanding the depth of market (DOM) is another useful skill to add to your technical analysis arsenal.
It measures the supply and demand of liquid tradable assets based on the number of open buy and sell orders for the chosen asset.
The more orders there are, the deeper, or more liquid, the market is.
It provides traders with information and lets them see where the price of the selected asset might go as soon as orders are filled, updated, or canceled.
Assets with a strong DOM are quite popular and have a large market cap.
If an asset is relatively liquid and has a hefty volume, it allows traders to place large orders without significantly affecting its market price. Securities with a low DOM belong to companies/projects with smaller market caps. By placing a large buy or sell order, a single trader can substantially affect the prices of those assets.
A depth of market chart
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The depth of market (DOM), or order book, comprises a list of pending orders for stock, security, or cryptocurrency. It is used as an indicator of the current interest in an asset and can help traders judge the likely direction of an asset’s price. It can also give traders an idea of the optimal time to buy or sell. The order book consists of three parts: buy orders, sell orders, and order history.
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For example, let’s say there’s a considerable imbalance of buy orders versus sell orders.
This may signal a move to a higher price due to buying pressure. The order book can help determine a cryptocurrency’s potential support and resistance levels. For instance, a bundle of large buy orders placed at a specific price, say $2,000, may show a level of support. On the other hand, a pile of sell orders at another price, like $1,300, might suggest an area of resistance.
Not only do crypto and stock trading have many tools in common, but several principles influencing both markets are also the same, such as supply and demand.
Candlestick charts are useful for skimming market trends, and understanding candlestick patterns is a good way to stay ahead of the game.
Don’t just blindly follow herd mentality and hype, do your technical analysis and stay rational, and don’t let emotions cloud your judgment. Like stocks, cryptocurrency markets are susceptible to emotional trading, which can sometimes make them extremely volatile. But don’t worry if you make some losses: it is something that happens to all traders, and that isn’t limited to the crypto world.
Try to view any losses in a positive light and learn from them. Let them teach you what not to do.
But at the same time, don’t become too accepting of losses. It is important to stay rational and sell off your investment if it is continually making a loss.
If you want to upgrade your trading skills further, keep reading because, in Chapter 9, we will be diving deeper into some of these aspects as well as discussing more technical aspects of trading and building up our ever-growing arsenal of trading tools.
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