Chapter 3. Trading and Investment strategies

What is a trading strategy?
A trading strategy is a plan that you adhere to when making deals. There is no single correct approach to trading, so the choice of strategy largely depends on the personality and preferences of the trader.

Regardless of the approach you choose, having a plan is important, as it defines clear goals and does not allow you to deviate from the course due to emotions. As a rule, you need to determine what and how you will trade, as well as entry and exit points.

In this chapter, we will look at several examples of popular trading strategies.

What is Portfolio Management?
Portfolio management consists in the selection of investments and their disposal. A portfolio is a collection of assets that can include anything from Beanie Babies toys to real estate. If you only trade cryptocurrencies, then most likely your portfolio will combine Bitcoin and other digital coins and tokens.

The first step is to think about your expectations regarding the portfolio. Are you looking for a basket of investments that will be relatively protected from volatility, or something riskier that can bring higher returns in the short term?

It is very useful to think about how you want to manage your portfolio. Some prefer a passive strategy, when investments, after they have been picked up, are not touched. Others choose an active approach, constantly buying and selling assets to make a profit.

What is risk management?
risk management illustration
Source: binance
Risk management is an important component of success in trading. It starts by identifying the risks you may encounter:

Market risk: potential losses if an asset falls in value.
Liquidity risk: Potential losses due to illiquid markets when it is difficult to find buyers for your assets.
Operational risk: Potential losses due to operational failures, such as human error, hardware and software malfunctions, or intentional dishonest behavior.
Systemic risk: potential losses due to the bankruptcy of players in the industry you are dealing with, which affects all businesses in the sector. This was the case in 2008, when the collapse of Lehman Brothers triggered a chain reaction in the global financial system.
As you can see, risk identification starts with the assets in your portfolio, but to be effective, both internal and external factors should be taken into account. Next, we need to assess these risks. How often can you meet with them? How serious are they?

After weighing the risks and assessing their possible impact on your portfolio, you can rank them and develop appropriate strategies and responses. Systemic risk, for example, can be mitigated by diversification, and market risk can be mitigated by using stop losses.

What is day trading?
Day trading is a strategy where positions are opened and closed on the same day. The term comes from traditional markets that are open at certain hours. At other times, day traders do not hold open positions.

As you probably know, cryptocurrency markets don't have opening hours. You can trade around the clock and seven days a week. Therefore, in the context of cryptocurrencies, day trading is called a style of trading when a trader closes positions less than 24 hours after opening.

Day trading often relies on technical analysis to determine which assets to trade. Since the profit in such a short period can be minimal, perhaps you would prefer to trade a wide range of assets to try to earn as much as possible. But some of them trade only one pair from year to year.

Obviously, this is a very active trading strategy. It can be very profitable, but it also entails significant risks. Therefore, day trading in general is more suitable for experienced traders.

Fundamentals of Technical Analysis for Bitcoin Traders

What is swing trading?
Swing trading also tries to make money on market trends, but the time horizon is longer here - usually positions are held from a few days to several months.

Often the goal is to find an asset that seems undervalued and has a chance to grow in price. Such an asset is bought and then sold when the price rises to make a profit. Or you can find overvalued assets that may fall in value. Then they can be sold at a high price, hoping to buy them back at a lower price.

As in the case of day trading, many swing traders use technical analysis. But since this strategy is aimed at a longer time, fundamental analysis can also be a valuable tool.

Swing trading is better suited for beginners, primarily because there is no such stress as in high-speed day trading. While the latter is characterized by rapid decision-making and a lot of time at the screen, in swing trading you can take your time.

What is positional trading?
Positional trading, or trend trading, is a long-term strategy. Traders buy assets to hold them for a long time (usually several months). The goal is to earn money by selling these assets in the future at a higher price.

Positional trading is distinguished from swing trading by the reasons for making deals. Positional traders are interested in long-term trends – they are trying to make money on the general direction of the market. Swing traders, on the other hand, usually seek to predict market fluctuations that are not necessarily consistent with a long-term trend.

Positional traders often prefer fundamental analysis because their time preferences allow them to wait for certain fundamental events. But that doesn't mean they don't use technical analysis. Although positional traders expect the trend to continue, technical indicators can warn them about a possible reversal of the course.

Like swing trading, positional trading is an ideal strategy for beginners. Again, a longer time horizon allows you to weigh your decisions well.

What is scalping?
Among all the strategies discussed here, scalping has the smallest time horizon. Scalpers try to take advantage of small price fluctuations, often opening and closing positions in a matter of minutes (or even seconds). In most cases, they rely on technical analysis to predict price changes, and use the difference between the price of supply and demand and other inefficiencies to make money. Due to the short time intervals, scalping transactions often bring only a small profit - usually less than 1%. But scalping bets on quantity, so that small winnings are gradually added up.

Scalping is by no means for beginners. Success requires a deep understanding of the markets, the platforms on which you trade, and technical analysis. However, for those who know their business, identifying the right patterns and using short-term fluctuations can be very profitable.

What is asset allocation and diversification?

The concepts of "asset allocation" and "diversification" are often used interchangeably. You are familiar with their principles if you have heard the saying "don't put all your eggs in one basket." When you put all your eggs in one basket, it creates a central point of failure – and this applies to your wealth as well. Investing all your savings in one asset exposes you to the same risk. If these are shares of some company and this company goes bankrupt, you will instantly lose all your money.

This applies not only to individual assets, but also to their classes. In the event of a financial crisis, you should expect that all the stocks you hold will lose value, because they are closely interrelated, that is, they often follow the same trend.

Good diversification is not just filling a portfolio with hundreds of different digital currencies. Imagine that governments of all countries will ban cryptocurrencies or quantum computers will crack the public key cryptography used in them. Such events will greatly affect all digital assets. Like stocks, they form a single asset class.

Ideally, it is worth distributing your wealth among several classes. Then if one of them shows poor results, it will not have a chain reaction on the rest of the portfolio. Nobel Prize winner Harry Markowitz described this idea in his modern portfolio theory. In essence, this theory justifies reducing the volatility and risks of investments in a portfolio by combining unrelated assets.

What is the Doe theory?

Source: binance
The Doe theory is a financial model based on the ideas of Charles Doe. Dow founded the Wall Street Journal and participated in the creation of the first American stock indexes, known as the Dow Jones Transportation and industrial indexes.

Dow's theory was not formulated by him, but is based on the market principles set out in his writings. Here are her key points:

The price takes into account everything: Dow was a proponent of the efficient market hypothesis, which assumes that markets reflect all available information about the price of their assets.
Market Trends: The Dow is often credited with the very idea of market trends as we know them today, with a distinction between primary, secondary and tertiary trends.
Phases of the primary trend: In the primary trends, the Dow defined three phases - accumulation, universal participation and excess and distribution.
Index correlation: Dow believed that the trend of one index cannot be confirmed if it is not observed in another index.
Importance of volume: The trend should also be confirmed by high trading volume.
Trends are valid until the reversal: if the trend is confirmed, then it continues until there is an obvious reversal.
It is worth remembering that this is not an exact science, but only a theory that may be incorrect. Nevertheless, this theory has a huge impact, and many traders and investors consider it an integral part of their methodology.

What is Elliott wave theory?

The basic pattern of Elliott wave theory. Source: cryptocartel.club
Elliott wave theory is the principle according to which the behavior of the market reflects the psychology of its participants. Although it is used in many technical analysis strategies, it is not an indicator and not a trading method as such. Rather, it is an approach to analyzing the market structure.

The Elliott wave pattern is usually a sequence of eight waves, each of which is either driving or corrective. There are five driving waves following the general trend, and three corrective ones directed in the opposite direction.

This pattern also has a fractal property, which means that one more Elliott wave pattern can be seen in each individual wave. Alternatively, you can zoom in and discover that the pattern you have explored is also a wave of a larger wave cycle.

Elliott's Wave Theory received mixed reviews. Some argue that this methodology is too subjective, as traders can find waves in different ways without breaking the rules. Like Dow theory, Elliott wave theory should not be considered as an exact science. Nevertheless, many traders have achieved great success by combining it with other technical analysis tools.

What is the Wyckoff method?

Source: academyfx.ru
The Wyckoff method is an extensive trading and investment strategy developed by Richard Wyckoff in the 1930s. His work is considered the cornerstone of modern methods of technical analysis for various financial markets.

Wyckoff proposed three fundamental laws: the law of supply and demand, the law of cause and effect, and the law of effort and result. He also formulated the theory of the universal operator, which largely overlaps with the phases of the primary trends of Charles Dow. His work in this area is especially valuable for cryptocurrency traders.

If we talk about practical application, then the Wyckoff method itself is a five-step approach to trading:

Determine the trend: What is it now and what will it be like next?
Identify strong assets: Are they moving with the market or in the opposite direction?
Find assets with sufficient reason: Are there enough reasons to open a position? Does the potential reward justify the risks?
Evaluate the probability of movement: Do indicators such as the Wyckoff buy and sell tests indicate a possible movement? What do the price and volume say? Is the asset ready to move?
Calculate the entry time: What do assets look like relative to the market in general? When is the best time to open a position?
The Wyckoff method was introduced almost a hundred years ago, but it remains very relevant today. Wyckoff's research has been extensive, so the above should be considered as a very concise overview. It is recommended to get to know his works more closely, as they provide irreplaceable knowledge on technical analysis.

What does "buy and hold" mean?
As the name suggests, the "buy and hold" strategy is to buy and hold an asset. This is a long-term passive game, when investors acquire an asset and then do not touch it regardless of market conditions. A good example of this in the crypto space is hodling, when investors prefer to hold cryptocurrency for many years instead of actively trading.

This approach is convenient for those who prefer passive investing, as there is no need to worry about short-term fluctuations or capital gains tax. On the other hand, patience is required from the investor, and it is assumed that the asset will not eventually become completely useless.

What is index investing?
Index investing can be considered as a kind of "buy and hold" strategy. As the name implies, investors seek to make money on the movements of assets included in a certain index. To do this, you can either buy assets yourself or invest in an index fund.

Again, this is a passive strategy. Its advantages are the diversification of assets and the absence of stress of active trading.

What is paper trading?
With paper trading, any strategy can be applied – but here the trader only pretends to buy and sell assets. It is useful for both beginners and experienced traders to test their skills without risking money.

For example, you think you have discovered a good strategy for predicting bitcoin downturns, and you want to make money on it. But before you risk all your funds, you can first try paper trading. To do this, you can simply record the price at the time of the "opening" and "closing" of your short position. You can also use some kind of simulator of popular trading interfaces.

The main advantage of paper trading is that it allows you to test your strategies without losing money if something goes wrong. You can find out the possible results of your steps with zero risk. Of course, one should be aware that paper trading gives a limited understanding of real conditions. It is difficult to reproduce the real emotions that you experience when your money is at stake. Paper trading without a simulator of real conditions can also give a false idea of the associated costs and commissions, if you do not take into account what they are on a particular platform.