What is Cryptocurrency Trading and How Does it Work?

Want to know what cryptocurrency trading is and how it works? You’ve come to the right place

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What is cryptocurrency trading?

Cryptocurrency trading happens when you buy or sell digital currencies with the aim of making a profit from the changing value of the underlying asset. Trading cryptocurrencies is as simple and secure as traditional forex currency trading

There are two main ways to trade cryptocurrency online: through a specialised brokerage such as Axi, or via a dedicated cryptocurrency exchange. From there you have two investment options: trading price movements via cryptocurrency CFDs, or by taking ownership of the asset itself. Each method has its pros and cons, as we’ll outline below.

Cryptocurrency CFDs can only be traded by Professional Clients due to FCA regulations.

How does cryptocurrency trading work?

There are two easy ways to invest in cryptocurrencies. The first is using a digital wallet to buy cryptocurrency at the current market rate – similar to investing in stocks. Once you own the currency, you profit by selling at a higher price than what you paid.

Alternatively, you can trade cryptocurrencies as CFDs. This is the same as trading FX and commodities, where you don’t own the ‘physical’ asset but instead trade on the price movements, meaning you can profit whether the price is going up or down.

Because cryptocurrency CFD trading allows you to use leverage, a small amount of capital can give you access to a higher value trade. For example, $1,000 in your trading account with leverage of 100:1 allows you to open trades to a value of $100,000. While leverage can generate high returns, it also increases the level of risk. Find out more about how to trade cryptocurrency.

What is blockchain?

Blockchain is the underlying technology behind cryptocurrency transactions that helps make them secure. Essentially, it is a decentralised network of computers that records a sequence of transactions, while at the same time making that chain of records transparent to all users in the network.

Each time a new transaction is recorded, a copy of this new block of data is added to the chain and updated across every computer on the network. So, despite not being controlled by a regular or governing authority, the transparency of the blockchain technology makes it easy to see if someone has tried to tamper with a transaction or record.

What is bitcoin?

Bitcoin was the first and remains the most well-known cryptocurrency. It makes use of blockchain technology to provide a highly secure and decentralised form of digital currency.

Since its inception, Bitcoin has become a widely accepted form of international currency, used by everyone from governments to small retail outlets. It can be traded openly on the markets as a CFD in the same way as other currencies and commodities, along with other cryptocurrencies such as Litecoin, Ethereum, Ripple and many more.

Cryptocurrency CFD Broker vs Cryptocurrency Exchange

Trading cryptocurrency CFDs through a broker

Brokers operate a service that specialises in trading important global asset classes such as FX, commodities, indices and cryptocurrencies.

Cryptocurrency trading through a broker is done via CFDs, using the broker’s existing networks and trading platforms, and does not require the use of a digital wallet. Because CFDs do not require the purchase of an underlying asset, trading cryptocurrency CFDs allow for the use of leverage which helps reduce the initial capital investment while gaining exposure to the full value of a trade. When compared with the cost of purchasing an asset outright, CFD trading through a broker typically offers lower barriers to entry. And because you are able to profit from either market direction, cryptocurrency CFD trading through a broker offers investment flexibility.

Trading cryptocurrencies through an exchange

To take full ownership of a cryptocurrency asset (such as an individual unit of Bitcoin), you would need to purchase it through an online exchange, using a digital wallet and paying the full current market value of the asset – similar to taking ownership of stocks.

Once you own the asset, you can only profit if the value increases relative to the purchase price at the point you sell. And because the digital currency market is decentralised with no governing authority to provide regulation, the risk of fraud and cyber theft is higher.

What drives the price of cryptocurrency markets?

The factors driving the price of cryptocurrencies are often similar to those that move traditional stock prices, giving us the ability to apply some familiar technical and fundamental analysis of the cryptocurrency market.

Techincals vs Fundamentals

Cryptocurrency correlation

While the cryptocurrencies with the largest market capitalisation (including Bitcoin, Ethereum and Ripple) all use different underlying technology, trends show that most of them move in the same direction, most of the time.

Technical analysis

The relative infancy of cryptocurrencies can make it difficult to project probable price targets for cryptocurrencies. One effective method is to use other traditional technical trading analysis like charts, signals and price patterns.

Media hype

Hype and media coverage is common at times when assets experience significant price fluctuations. This added interest, if acted upon, has the potential to artificially alter the price of the underlying cryptocurrency.

On-chain analysis

On-chain analysis is specific to cryptocurrencies and is built on public information provided from blockchains. Similar to price-earnings ratio in traditional stocks, you analyse the number of transactions to see how heavily it is being traded and speculate whether the market price reflects the true value.

Is cryptocurrency trading profitable?

Analysis of historical price charts show that the high volatility environment of cryptocurrency trading can be very profitable – especially given it is open 24 hours. When trading cryptocurrencies, you should always consider factors such as the amount of available liquidity in the underlying market, as this can greatly affect important factors like spreads and entry points.

What are the advantages of trading cryptocurrency?

As more new cryptocurrencies are created and join the market, more people want to know what are the advantages of trading crypto.

Profit in either market direction

Cryptocurrency CFD trading is based on real-time price movements, which means you have the advantage of being able to profit when the price goes up or down, depending on which way you speculate in your trade. This is unlike investing directly into a cryptocurrency where you must rely on it increasing in value before you can bank a profit.

Lower investment needed

Using leverage to trade cryptocurrency CFDs gives you flexibility with the amount of capital you need to trade. For example, if you have $1,000 in your account and apply leverage of 100:1, you can gain exposure to a trade value of $100,000 (note that leverage can magnify both profits and losses). To invest directly in the asset, rather than trade it as a CFD, you must pay the full market price up front.

No need for a digital wallet

To invest in ‘physical’ cryptocurrency for the purpose of owning it, you need to have a digital wallet and accept the inherent online risk (such as hacking) involved in running it. Trading a cryptocurrency as a CFD can be done on an existing and proven trading platform, with added assurance of the trade being executed by a broker with regulatory compliance and accountability.

Hedge against fiat currency

As cryptocurrency usage and investment has become more popular and moved further towards the mainstream, the currencies themselves have become increasingly legitimised. With that has come stability, growth and an increasing viability and value as a widely accepted alternative form of currency.

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Cryptocurrency trading FAQs

No – unlike regular markets, the cryptocurrency market is open 24 hours a day, 7 days a week. However, when trading cryptocurrency CFDs with Axi, please consider the price movements based on the details in the product schedule.

In practice, trading cryptocurrency CFDs is no different to trading any other financial instrument, such as forex, gold, oil or stock indices. This is because you are only trading the price movements and are not investing the often significant sums needed to take ownership of the underlying asset itself. 

However, as a trader you must remember that every asset is subject to unique market forces and behaves in a different way (for example, some products are more volatile than others). This is why technical and fundamental analysis is important. And when trading any financial product, you should have an appropriate risk management strategy in place and make use of the features built into the trading platform that help protect your account, such as Stop Loss and Take Profit tools.

The spread is the difference between the Bid and the Ask price of a particular cryptocurrency, with the Bid price usually lower than the Ask price. The spread will change according to the amount of liquidity and volatility in the markets, so it’s important to check the latest prices before you commit to a trade.

Just like the days of the gold rush, ‘mining’ for cryptocurrencies is a way to extract money from a nominally free resource. However, cryptocurrency mining is a technologically complex undertaking.

Essentially, mining is the way a new unit of cryptocurrency enters circulation – you might think of it as being somewhat equivalent to minting a traditional currency. But the way it happens isn’t through a printing press – it’s by applying significant computing resources to solve complex mathematical equations. 

As the miners go about their work, what they are effectively doing is taking on a role of de facto auditor and verifying blocks of cryptocurrency transactions to ensure no one is trying to use the same unit of cryptocurrency twice. As a reward for helping ensure the validity of the cryptocurrency as a whole, the miner is paid through the creation of a new unit (or sub-unit) of the underlying cryptocurrency. 

Please note that this is an extremely simplified outline of cryptocurrency mining. Anyone interested in becoming a cryptocurrency miner should investigate it thoroughly first.

A ‘lot’ is a commonly used term in trading and it represents a standard unit of a particular asset. For example, when trading Forex, a lot is 100,000 units of a currency. So, if you bought 1 lot of USD, you would be buying $100,000 worth of USD.

For cryptocurrency CFDs, lots refer to a set amount of the individual cryptocurrency that a trader can buy or sell in each transaction. At Axi, 1 lot represents 1 ‘coin’ for the majority of the available cryptocurrencies, with the exception being Ripple (XRPUSD) where the contract size per 1 lot represents 1,000 coins.

Using the example of Bitcoin vs US Dollar (BTCUSD), if a trader entered a buy at the trade size of 1 Lot, for every tick increment of 0.1, the trader would be making US$1.

Essentially, leverage means borrowing funds from a broker to increase the size of an individual trading position beyond the cash balance the trader may have. Note that while leverage can present profits from relatively small price changes in currency pairs, it can amplify losses as well.

Let’s say you have $1,000 in your account and you decide to open a $10,000 position. This means you will be trading with 10 times leverage on your account (10,000/1000 = 10:1 leverage). In cryptocurrency trading, it’s not uncommon to see leverage going up to 100:1. This means, for every $100 in your account, an individual is allowed to trade up to $10,000 in value. In other words, the trader’s account now has a leverage ratio of 100:1.

If an individual has the option to open a trading account with a leverage of 500:1. That means for every $1 of deposit, the broker will effectively lend you $500. This in turn means that the individual is taking a much larger position then the initial amount that was deposited. 

It is for this reason that leverage can be a double-edged sword, amplifying both profits and losses. Hence, it is important to practice proper trade and risk management to ensure that leverage can be used to the trader’s advantage.

It is very common to see the term “margin” when trading with leverage in a trading account, where margin simply represents a percentage of the full amount of your trade. To continue the above example, based on a margin requirement of 10% and using a 100:1 leverage ratio, the margin required to open a $10,000 position will be $100. 

“Free margin” refers to the amount of funds that are available for a trader to open a position. On the other hand, “used margin” refers to the amount of funds that are used to maintain current open positions that are still running. You could think of “used margin” as a sum of money that is put aside from your account balance in case the position swings against you to the point of liquidation.

In the event that “free margin” has been used up and there isn’t enough margin left in the trading account, if an open trade has any drawdown against the trader, this is where the broker will issue a “margin call” warning to the trader. This alerts the trader that they need to add funds to their account in order to keep the position open. If no additional margin is added, the broker may close the position in order to prevent further losses.

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