We give you a peek into the inner workings of a digital exchange.
Hey Binancians, thanks for checking out the latest installment in our Education 101 Series. If you missed our previous articles, check them all out here in Your Guide to Crypto Literacy.
When people start learning about Bitcoin or purchase their first cryptocurrency, one of the first questions that tends to come up is: “What can I do with my crypto?”
We’ll discuss some of the different applications of blockchain and distributed ledger technology in our upcoming series on Blockchain Applications but the truth of the matter is that for now, trading and investment remain the primary uses of cryptocurrency.
So, how does someone get started on the path to being a great trader? Read on to find out! This article explains what trading is, provides a glimpse into the inner workings of a digital exchange, and outlines some of the basic tools and strategies traders use to hone their craft.
A Brief Introduction to Trading
In contrast with investing, where people attempt to make a profit by holding assets over long periods of time, trading involves trying to make profits by swapping assets over short periods of time, typically hours, days, or weeks.
Traders and investors both aim to make profits by holding the right assets at the right time; they just use different strategies to try and achieve their goals.
Some traders follow the mantra, “buy low, sell high,” but others use financial products or strategies that allow them to take advantage of fluctuations in the price of assets in other ways.
Different types of trading are typically classified using four different categories based on how long the trader intends on holding their position:
- Scalping is the shortest form of trading, taking place over seconds, minutes, and occasionally hours.
- Day trading gets its name from the fact that day traders typically open and close their trading positions within the same day.
- Swing trading involves holding positions over days, weeks, or sometimes months. For those who hold day jobs or don’t want to take on the commitments it takes to open and close trades on the same day, swing trading may be an ideal option.
- Position trading is as close as trading gets to investing. Position traders may hold an asset or position for weeks, months, or even years while waiting for their opportunities to play out.
In traditional markets where securities and commodities are traded, exchanges are only open during certain hours.
Forex and cryptocurrency markets, however, operate 24/7, with digital exchanges open for trading to individuals throughout the world in every timezone, at any time.
Since digital asset traders don’t have to worry about markets opening and closing, we can also examine trading strategies in terms of how the trades will be executed:
- Algorithmic trading involves developing software programs that automatically take advantage of opportunities when they occur, giving traders the opportunity to profit by making lots of small trades over a short period of time.
- Arbitrage occurs when someone figures out how to sell an asset in one place at a higher price than they can buy it in another. For example, someone who buys BNB on one exchange for $20 and sells it for $25 on another makes a $5 arbitrage.
- Market making make their profits by buying and selling an asset and keeping the “bid-ask spread,” or the difference between the bid and asking prices.
- Margin trading involves borrowing assets to create larger trading positions. (Caution: Margin trading is a high-risk strategy and should only be used by experienced traders)
- Short selling takes the idea of “buy low, sell high” and flips it on its head. Instead of looking for assets that will appreciate in value, traders who deal in short sales bet on the price of an asset falling over time.
Makers, Takers, and Candlestick Creators
No matter how you do your trading, in order to make trades, you need to use an exchange.
When we talk about trading, some picture well-dressed professionals examining complicated charts and graphs on large monitors while others picture traders shouting orders and flashing hand signals on the floor of a stock exchange.
Exchanges allow their users or customers to trade assets by enabling different assets to be listed on the exchange and providing a way for people to trade those assets. Most digital exchanges rely on order books to facilitate peer-to-peer trading.
An order book displays all of the active buy and sell orders for a given asset.
The highest price a trader is willing to pay for an asset is referred to as a bid while the lowest price a trader will sell their asset for is called an ask. Traders can place orders a variety of different ways but all fall into two categories:
- Makers supply liquidity to the order book by placing orders that other traders can fill. Exchanges like Binance.US generally offer lower maker fees to provide some incentive for traders who provide liquidity to the exchange.
- Takers place orders that fill existing orders in the order book.
Some of the different types of orders a trader may make include:
- Limit orders allow the trader to set a price at which they’re willing to buy or sell an asset. These would be categorized as maker orders.
- Market orders are the most basic form of a taker order. When a trader places a market order, they agree to buy or sell an asset as the best available price.
- Stop orders allow the trader to place a market order for an asset once it reaches a specified price.
- Stop-Limit orders allow the trader to set a price at which the exchange will place a limit order on the trader’s behalf.
How to evaluate investment opportunities
Traders have developed a wide variety of tools and strategies for evaluating different opportunities but approaches to evaluating investment opportunities can be separated into two categories: technical analysis and fundamental analysis.
- Fundamental analysis involves trying to identify the intrinsic value of an asset. Depending on the type of asset at hand, this can mean examining things like industry trends, economic trends, and financial statements.
- Technical analysis uses statistics to identify trends in trading activity and provide insight into how the price of an asset might fluctuate in the future.
Fundamental and technical analysis are often presented as mutually exclusive but many traders use both when making decisions about their trading strategy.
Whatever analysis we choose to conduct, the question remains the same: do we think the asset we’re considering is available now for less than it will be worth in the future?
Knowing how to analyze trading opportunities is a fundamental skill for traders but the key to success is learning how to manage risk while taking those opportunities.
Follow along as we add to our Binance.US Education 101 Series: Your Guide to Crypto Literacy
#1 Demystifying Digital Dollars
#2 Evolution of the Internet
#3 Finance, Rhymes with …
#4 Back that Asset Class Up
#5 What are Cryptocurrencies?
#6 Defining Decentralized Finance
#7 Cryptoeconomics Explained
#8 Intro to Consensus Algorithms
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This material has been prepared for general informational purposes only and should NOT be: (1) considered an individualized recommendation or advice; and (2) relied upon for any investment activities. All information is provided on an as-is basis and is subject to change without notice, we make no representation or warranty of any kind, express or implied, regarding the accuracy, validity, reliability, availability or completeness of any such information. Binance.US does NOT provide investment, legal, or tax advice in any manner or form. The ownership of any investment decision(s) exclusively vests with you after analyzing all possible risk factors and by exercising your own independent discretion. Binance.US shall not be liable for any consequences thereof.