Crypto trading strategies you need to know

• Crypto trading strategies are rule-based plans for buying and selling digital assets, ranging from simple methodologies to complex systems involving technical analysis and algorithms.

• Dollar-cost averaging (DCA) is a beginner-friendly strategy involving regular, fixed purchases of cryptocurrency, designed to be simplistic and less time-intensive.

• Advanced trading strategies, such as Elliott Wave Theory and traditional chart patterns, require extensive market knowledge and incorporate detailed technical analysis and risk management.

A crypto trading strategy is a rules-based plan of action that determines when a trader buys and sells digital assets, such as Bitcoin (BTC), Ether (ETH).

These strategies range from simple methodologies to more complex systems involving technical analysis, algorithms, and other advanced tools.

Some traders choose to backtest and forward-test potential strategies to try and identify measurable, repeatable patterns in a cryptocurrency's historical price action. By analyzing this information, traders hope to gain a competitive edge that enables them to extract value from other crypto market participants.

It's important to note that a successful trading strategy often depends on many factors, such as the trader implementing the strategy and market conditions. Additionally, past performance does not guarantee future results, and crypto markets are constantly evolving.

The ability to demonstrate that a strategy is consistently profitable with statistical significance is part of what marks a successful trader, but the strategy itself is just one very important piece of the puzzle.

For any trader to have a long-term positive expectation from their interaction with crypto markets, a tried-and-tested strategy is considered essential.

Some research indicates that most traders lose money, in part, because they do not cut their losses when a trade turns bad. Therefore, having a clear strategy in mind of when to enter and exit a trade may prove helpful in minimizing common issues.

There is a wide range of strategies that can be successfully applied to markets. Which one works best for you can depend on a variety of factors, such as your experience level, risk tolerance, and how much time you have available.

Dollar-cost averaging (DCA) is widely regarded as a lower-risk, less time-intensive crypto trading strategy compared to many other options.

Its straightforward, "set it and forget it" approach makes it a popular option for novice traders who might find more complex strategies daunting or too time-consuming.

In short, DCA is the simple act of buying a nominal amount of cryptocurrency at fixed, repetitive intervals.

As an example, let's imagine a trader decides they want to DCA into Litecoin (LTC).

With this strategy, they only need to make two decisions: how much they would like to buy and how often.

In this scenario, the person decides to buy $100 worth of Litecoin at midday every Monday. To make things easier, they opt to fully automate the process using a recurring buy feature like the one Kraken offers.

Using recurring buys, a person can configure the interval, amount and crypto asset they wish to buy. From then on, the crypto exchange automatically buys the chosen asset at the specified time until the trader instructs it to stop.

Risks of dollar-cost averaging

With crypto dollar-cost averaging, it's very important that traders:

• Only invest an amount that they can afford to lose.

• Research which assets would be suitable for DCA, based on extensive backtesting. (Many assets would be highly unsuitable for DCA, in part because of the lack of historical price data or because of the high failure rate of projects in the crypto space.)

• Compared to other strategies, such as lump-sum investing, DCA can result in lower-than-expected returns.

If traders risk more than they can afford to lose, not only is it considered poor risk management that can lead to harmful losses, but the added psychological weight of going all-in on a single trade can make it hard to follow a strategy consistently.

Another reason why risk management is so important here is that this particular strategy does not offer a formula for stop losses or take profits. Rather, you have to decide how long you want to DCA for.

As with any strategy, the value of your portfolio can fluctuate while the strategy is in play. With this in mind, it's important to invest an amount that matches your risk appetite. Doing so may help traders continue to execute the strategy while it is in drawdown (the value of the portfolio is declining). Knowing what a typical drawdown looks like based on previous research can serve the same function.

Due to the high risk of liquidation, many traders do not find DCA suitable for crypto futures trading.

For more information, check out our Kraken Learn guide, What is dollar-cost averaging?

Beginner strategies are often largely prescriptive, with clear and simple instructions.

Advanced trading strategies, on the other hand, require a trader to combine information from multiple variables in real time, and hence require a lot more experience and a deeper understanding of markets.

In most cases, it can take years to become a profitable trader due to the difficulty of mastering a more advanced approach to the market.

Generally speaking, professional trading can be broken down into two categories:

1. Discretionary trading, which involves a trader combining various sources of information to make subjective decisions about the future direction of a market.

2. Systematic trading, a rules-based approach which may involve the use of indicators, algorithms and automation to execute trades, minimizing the impact of human error.

The following section describes a handful of discretionary strategies, which combine technical analysis with risk management to generate trading setups.

Elliott Wave Theory (EWT) — developed by Ralph Nelson Elliott in the 1930s — posits that markets move in identifiable wave-like patterns that are either impulsive or corrective.

While opinions vary on the reliability of this strategy, it remains a popular option for many traders. Here's how the strategy works:

Traders combine EWT with technical analysis to identify a) The direction of a trend b) The maturity of a trend and c) Where a trend may end and restart.

• Five impulsive waves establish the direction of a trend.

• Three counter-trend corrective waves mark the retracement.

• The strategy can be used to forecast how a market might behave.

• The Fibonacci retracement tool is used to determine where a correction can end.

• There are detailed rules and guidelines that must be followed.

• The degree to which EWT is useful as a predictive tool is contested.

• From examining how markets actually behave, impulsive moves tend to contain three waves, rather than 5.

Following this strategy, traders may choose to buy a digital asset or go long after identifying an impulse wave up, or conversely, go short during a corrective wave.

Crypto markets often trade in identifiable patterns or shapes, often referred to as "Basic Patterns."

Broadly speaking, there are two main categories of chart patterns:

• Reversal patterns

• Continuation patterns

Several patterns exist within each of these two categories, which we'll explore in more detail below.

Note that each pattern has a bullish and bearish variant, and indicates either a trend reversal or a continuation. Crucially, a trader has to know precisely how to trade each pattern, as false breakouts can occur.

Each pattern has its own rules which must be applied with the correct risk management.

Classic reversal patterns

These types of chart patterns indicate that the current trend may swiftly change direction. A bullish reversal, for example, indicates that prices are about to start rising, and vice versa.

Head and shoulders 

The simplest way to understand a head-and-shoulders pattern is to think of it as a trend breaking down.

After establishing a higher high—marking the continuation of a trend—the market then prints a lower high, which precedes a break of market structure, marking the end of the trend and the beginning of a reversal.

The breakdown from the 'neckline' (the support level below the head and shoulders) is the trigger to sell the asset in question.

An inverted head and shoulders pattern (the same pattern in reverse) can mark the end of a move down.

Double top

Double tops can form when a crypto asset's price is consolidating after a move up. After establishing a clear resistance level, which can mark the range high, the price then fails to break it on the second attempt.

What follows is a breakdown from the range, which can be traded with a stop behind the origin of the breakdown, above the range low.

Triple tops are very similar to double tops, only with an additional failure at resistance. 

Falling wedge

Falling wedges often form as the momentum of a downward move slowly loses steam. As lower lows become increasingly stunted, and buyers slowly start to overpower sellers, price can form a wedge pattern.

Before the wedge resolves into a breakout, the price becomes increasingly compressed, eventually bursting out of the wedge with a notable spike in volume.

Traders often look to trade the breakout of the wedge to a resistance level above. A rising wedge is the opposite of a falling wedge, with buyers giving way to sellers.
 

Classic continuation patterns

These types of chart patterns suggest that the current trend will likely continue. A bearish continuation, for example, signals that falling prices will continue to tumble farther.

The descending triangle

The breakdown on BTC in November 2018 from $6,000 was a fine example of a bearish descending triangle (a.k.a, bearish triangle) in action.

The descending triangle depicts sellers repeatedly testing a key level of support, before it finally gives way, followed by a violent move down.

In crypto, it has often been called the "bouncing ball meme," because it is comparable to a ball bouncing lower and lower as the impact of gravity slowly brings it back to earth.

Traders might look to get short on confirmation that the key support level has been broken (a close below the level on a significant time-frame).

The flag

Flags can either be bullish or bearish, marking the continuation of a trend in either direction.

In the bullish case, a flag denotes a pause in the trend where short sellers take the opportunity to cover their positions and buyers take some profit. Buyers, however, remain in control. After a short downward move—which takes the form of a flag pointing slightly down—price breaks out to the upside and the trend continues.

As with all breakout trades, traders might look to get in on the move using some form of confirmation and invalidation at an area below where the breakout occurred.

The symmetrical triangle (pennant)

Similar to a flag, a symmetrical triangle marks a brief pause in a trend before a continuation. However, unlike a flag, the symmetrical triangle is a coiling of price before an explosive move, often in line with the prevailing trend.

Neither sellers nor buyers show any superiority when the price forms a symmetrical triangle. They create an equilibrium before one side eventually overpowers the other.

Volume often decreases during symmetrical triangles as traders wait for the conclusion of the pattern. Once the triangle is broken, volume typically spikes sharply.

What to know about traditional chart patterns

• There are many more chart patterns that may be used to offer trade setups. The above is merely a primer to offer some insight into this approach and how it might be used.

• How traders identify, draw and trade patterns is highly subjective. Where one trader may see a falling wedge, another may make a case for a descending triangle or a range breakout. What's crucial, however, is that proper risk management is applied in all scenarios and that each setup has a clear entry criteria, invalidation and take-profit.

• In stocks and crypto, there are services available that use AI to screen the market for certain patterns. Note that being able to identify a pattern is just the first step — using that information to trade successfully is an entirely different prospect.

• Very often, a chart will print a pattern, but there will be little or no follow-through after the initial breakout. This is known as a 'fakeout' (a fake breakout) - and is something that all traders should be mindful of. The purpose of a fakeout is to catch traders offside and force them to close their positions to prevent further losses. When a large volume of trapped traders close their positions at the same time, it can drive prices lower or higher (depending on the direction).

• Markets often breakout upwards from bearish patterns, and breakout downwards from bullish patterns. There is no guarantee that any pattern will resolve as it is expected to.

The use of support and resistance (S/R) in trading is one of the most widely-used approaches to crypto markets, and is adopted by many professional traders.

The basic premise behind S/R is that traders will repeatedly defend key price levels, and as such, they may offer trade opportunities.

If we look at the example below, we can see that a cryptocurrency's price has repeatedly bounced from the area of support highlighted. Being able to identify such a level can offer traders a chance to buy. Note also that the price deviated from the level before reclaiming it shortly thereafter. This sequence of price action is often used to generate trade opportunities.

The support and resistance flip

What was once a support can become future resistance. This concept can be applied in a setup known as the 'S/R Flip'.

If you think of a market as a series of S/R levels that are constantly being tested and broken, it's much easier to understand how S/R levels can offer trade setups from both sides.

Famous trader, Peter Brandt, introduced the 'ice-line' as a way to conceptualize S/R flips.

Imagine walking along a frozen lake when, suddenly, the ice gives way and you fall through into the water below. The momentum of the fall carries you down into the water and slightly further along from where you entered. As you approach the surface, you encounter the 'ice-line', and what was formerly supporting you from above is now resisting you from below.

This is how S/R flips work.

The price dips into this level multiple times, before eventually breaking through. When the price returns to this area, it gets rejected. What was formerly a support level has now become a key resistance level.

Derivative traders might look to go short in this area with a stop behind the origin of the breakout.

There are an endless number of ways that a trader can approach the crypto market. The examples described above represent just a few examples.

Here are some other widely-used strategies that you may want to research:

• Fibonacci levels: using the fibonacci retracement tool to identify levels to enter a pullback in a market that is trending.

• Range trading: the art of identifying ranges in markets, then waiting for price to reach the extremes (either the range low or range high) in an attempt to trade it to the other side.

• Indicator-based trading: many traders use indicators such as the Relative Strength Indicator (RSI) and Moving Average Convergence and Divergence (MACD) to time entries when a market appears to be reversing. One such example is by looking for bearish and bullish divergences.

• Algorithmic trading: discretionary traders use their judgment to enter and exit traders. Algorithmic traders use automation to have a strategy implemented for them.

Yes. While there are many established strategies that you can research further, it's also possible to test your own ideas about how the crypto market behaves.

For any strategy to work, there has to be some rational basis derived from close examination. A trader cannot simply speculate on what might work. They must look at what has worked in the past, then shape their approach accordingly. This is where backtesting and forward testing can prove useful.

Here are some steps you may want to take if you want to try developing your own cryptocurrency trading strategies.

1. Formulate an 'if X then Y' hypothesis about a market. For example, let's imagine that a trader believes that price often treats psychological numbers as support and resistance.

2. Define the strategy parameters, such as how you would enter and exit using the hypothesis in question. Using the same example above, a trader might test entering a short position as price approaches each $500 increment, with a stop-loss order set $100 behind each level.

3. Test the strategy over a large sample of historical data to determine its efficacy. Many charting packages allow you to backtest strategies by replaying price action bar-by-bar.

4. If the backtesting results are promising, a trader can then test the strategy in real-time, known as forward testing.

Please note, this is a reductionist guide. There are many individual steps to backtesting a strategy. Many traders also opt to backtest their strategies in the python programming language.

Once again, just because a strategy has been shown to be successful in the past does not mean that it will work when tested or implemented in real-time.

1. Research and find a strategy that suits your lifestyle and personality. Any strategy must suit the way you like to trade and one that fits how often you can be at your desk (some traders with families and full-time jobs, for example, may not be able to trade frequently).

2. Some people might find it useful to backtest and forward-test potential strategies before they start actively trading.

3. Becoming a specialist in one strategy might prove beneficial over studying multiple systems. There are an infinite number of ways to trade financial markets, but studies show that most traders make little progress because of a phenomenon known as "strategy hopping."

4. Many find using a trading journal to track the performance of their strategy over time to be a beneficial learning tool. This can help traders identify trends in their winning and losing trades, which they might reflect on to make changes.

The short answer is "it depends."When looking at research into the efficacy of trading strategies, the picture is mixed:

• One study analyzed a range of indicator-based strategies (such as RSI and MACD), and found that they performed no better than a purely random strategy.

• Other studies paint a far more optimistic picture. One study showed via a simulation that it may well be possible to profitably trade corporate earnings announcements.

• Another piece of research showed that strategies based on Bollinger Bands and RSI could outperform a buy-and-hold approach in stocks.

• Analysis of backtested quantitative strategies shows that they are able to outperform the market, but the paper highlighted the pivotal role of human discretion.

• Here, you can see from various backtests of chart patterns in stocks that some patterns can be successful (note that we are only able to see data from the last year, which limits any conclusions we can draw).

• Research into DCA showed that it was a successful strategy over a ten-year period, but also that Value Averaging (buying more during a dip and less while price is appreciating) was superior.

At the very least, there is clear evidence to show that trading strategies can be successful. However, the degree to which they are successful is dependent on several factors. Many of which we've highlighted above.

Trading strategies provide traders with a logical formula for entering and exiting trades. Any strategy should be extensively researched before being deployed into a market, and all traders should understand that many factors impact on how successful any strategy will be.

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