Trading is a fundamental economic concept that involves buying and selling assets. These can be goods and services, where the buyer pays the compensation to the seller. In other cases, the transaction can involve the exchange of goods and services between the trading parties.
In the context of the financial markets, the assets being traded are called financial instruments. These can be stocks, bonds, currency pairs on the Forex market, options, futures, margin products, cryptocurrency, and many others. If these terms are new to you, don’t worry – we’ll explain them all later in this article.
The term trading is commonly used to refer to short-term trading, where traders actively enter and exit positions over relatively short time frames. However, this is a slightly misleading assumption. In fact, trading may refer to a wide range of different strategies, such as day trading, swing trading, trend trading, and many others. But don’t worry. We’ll go through each of them in more detail later.
Investing is allocating resources (such as capital) with the expectation of generating a profit. This can include using money to fund and kickstart a business or buying land with the goal of reselling it later at a higher price. In the financial markets, this typically involves investing in financial instruments with the hopes of selling them later at a higher price.
The expectation of a return is core to the concept of investment (this is also known as ROI). As opposed to trading, investing typically takes a longer-term approach to wealth accrual. The goal of an investor is to build wealth over a long period of time (years, or even decades). There are plenty of ways to do that, but investors will typically use fundamental factors to find potentially good investment opportunities.
Due to the long-term nature of their approach, investors usually don’t concern themselves with short-term price fluctuations. As such, they will typically stay relatively passive, without worrying too much about short-term losses.
Both traders and investors seek to generate profits in the financial markets. Their methods to achieve this goal, however, are quite different.
Generally, investors seek to generate a return over a longer period of time – think years or even decades. Since investors have a larger time horizon, their targeted returns for each investment tend to be larger as well.
Traders, on the other hand, try to take advantage of the market volatility. They enter and exit positions more frequently, and may seek smaller returns with each trade (since they’re often entering multiple trades).
Which one is better? Which one is more suitable for you? That’s for you to decide. You can start educating yourself about the markets, and then learn by doing. Over time, you’ll be able to determine which one suits better your financial goals, personality, and trading profile.
Fundamental analysis is a method for assessing a financial asset’s valuation. A fundamental analyst studies both economic and financial factors to determine if the value of an asset is fair. These can include macroeconomic circumstances like the state of the wider economy, industry conditions, or the business connected to the asset (if there’s one). And these are often tracked through macroeconomics leading and lagging indicators.
Once the fundamental analysis is complete, analysts aim to determine whether the asset is undervalued or overvalued. Investors can use this conclusion when making their investment decisions.
In the case of cryptocurrencies, fundamental analysis may also include an emerging field of data science that concerns itself with public blockchain data called on-chain metrics. These metrics can include the network hash rate, the top holders, the number of addresses, analysis of transactions, and many more. Using the abundance of available data on public blockchains, analysts can create complex technical indicators that measure certain aspects of the overall health of the network.
While fundamental analysis is widely used in the stock market or Forex, it's less suitable for cryptocurrencies in their current state. This asset class is so new that there simply isn’t a standardized, comprehensive framework for determining market valuations. What’s more, much of the market is driven by speculation and narratives. As such, fundamental factors will typically have negligible effects on the price of a cryptocurrency. However, more accurate ways to think about cryptoasset valuation may be developed once the market matures.
Technical analysts work with a different approach. The core idea behind technical analysis is that historical price action may indicate how the market is likely to behave in the future.
Technical analysts don’t try to find out the intrinsic value of an asset. Instead, they look at the historical trading activity and try to identify opportunities based on that. This can include analysis of price action and volume, chart patterns, the use of technical indicators, and many other charting tools. The goal of this analysis is to evaluate a given market’s strength or weakness.
With that said, technical analysis isn’t only a tool for predicting the probabilities of future price movements. It can also be a useful framework for risk management. Since technical analysis provides a model for analyzing market structure, it makes managing trades more defined and measurable. In this context, measuring risk is the first step to managing it. This is why some technical analysts may not be considered strictly traders. They may use technical analysis purely as a framework for risk management.
The practice of technical analysis can be applied to any financial market, and it’s widely used among cryptocurrency traders. But does technical analysis work? Well, as we’ve mentioned earlier, the valuation of the cryptocurrency markets is largely driven by speculation. This makes them an ideal playing field for technical analysts, as they can thrive by only considering technical factors.
That entirely depends on your trading strategy. Actually, why not use both? Most market analysis methods work best when they’re combined with other methods or indicators. This way, there’s a bigger chance of finding more reliable investment opportunities. Combining different trading strategies can also help eliminate biases from your decision-making process.
This concept is sometimes referred to as confluence. Confluence traders combine multiple strategies into one that harnesses benefits from all of them. The idea is that the trading opportunities presented by the combined strategies may be stronger than the ones provided by only one strategy.
The price of an asset is simply determined by the balance of supply and demand. In other words, it’s decided by the buyers and sellers. Where supply meets demand, there’s a market. But what else can drive the value of a financial asset?
As we’ve discussed earlier, there can be fundamental factors, such as the state of the economy. In addition, there can be technical factors like the market capitalization of a cryptocurrency. Also, there may be other factors to consider, such as market sentiment or recent news.
However, these are just that – factors to consider. What really determines the price of an asset in a given moment is simply the balance of supply and demand.
A market trend is the overall direction where the price of an asset is going. In technical analysis, market trends are typically identified using price action, trend lines, or even key moving averages.
Generally, there are two main types of market trends: bull and bear market. A bull market consists of a sustained uptrend, where prices are continually going up. A bear market consists of a sustained downtrend, where prices are continually going down. In addition, we can also identify consolidating, or “sideways” markets, where there isn’t a clear directional trend.
Bitcoin has been in a bull market throughout all its existence.
It’s worth noting that a market trend doesn’t mean that the price is always going in the direction of the trend. A prolonged bull market will have smaller bear trends contained with it, and vice versa. This is simply just the nature of market trends. It’s a matter of perspective as it all depends on the time frame you are looking at. Market trends on higher time frames will always have more significance than market trends on lower time frames.
A peculiar thing about market trends is that they can only be determined with absolute certainty in hindsight. You may have heard about the concept of hindsight bias, which refers to the tendency of people to convince themselves that they accurately predicted an event before it happened. As you’d imagine, hindsight bias can have a significant impact on the process of identifying market trends and making trading decisions.
You may have heard the phrase that “the market moves in cycles”. A cycle is a pattern or trend that emerges at different times. Typically, market cycles on higher time frames are more reliable than market cycles on lower time frames. Even so, you can eventually find small market cycles on an hourly chart just as you may do when looking at decades of data.
Markets are cyclical in nature. Cycles can result in certain asset classes outperforming others. In other segments of the same market cycle, those same asset classes may underperform other types of assets due to the different market conditions.
It’s worth noting that it’s almost impossible to determine in any given moment where we currently are in a market cycle. This analysis can be done with high accuracy only after that part of the cycle has concluded. Market cycles also rarely have concrete beginning and endpoints. As it turns out, being in the present moment is an exceptionally biased viewpoint in the financial markets.
