Transitioning from Traditional Markets to Cryptocurrencies


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Traditional markets — equity, bonds, futures, options, Forex, etc. — provide traders with a vast selection of instruments to trade and invest in. There are seemingly no problems in switching from one market to another, if the current environment offers no trading opportunities. However, the traditional financial system is interconnected too deeply: volatility and volume are gone from virtually every marketplace. The flourishing crypto market that is still enjoying its independent nature has come to the rescue for traders. Why crypto trading is attractive and what newbies may face in this market — we are answering these questions in what follows.

2008 Crisis Aftermath

The policy pursued by central banks around the world to save the economy during the 2008 crisis aimed at pumping in liquidity has brought the financial system to a reality distortion: money has become virtually free, and rates are even negative in some countries. And these measures have had a material effect on traders active in any segment of the traditional financial system.

The US stock market is the most striking example. The bull market has been shamelessly long: if the S&P Index returns positive results by the end of the year, 2018 will be the tenth consecutive year of growth breaking the record of 1991–1999. 2017 has become the pinnacle of low volatility amid Trump’s tax reform expectations: the “fear index”, VIX, has been continuously breaking its record lows.

All of the above has resulted in a dry season spanning multiple years for active traders: surely, the longer the markets stay calm, the lower the volatility and trade volume. This is why, all asset classes move less aggressively, volatility declines, and it’s becoming ever harder to trade big size orders. Conventional correlations disappear, past news drivers stop working, and many trading strategies die. Mistakes become more costly in this environment, making it harder to stay profitable. A calm market is not particularly bad for long-term investors (who employ the buy&hold strategy), which is why passive investing like ETFs (of which, there is a vast quantity) has become so popular in recent years. The absolute majority of actively-managed funds, however, underperform vs indexes.

In contrast to traditional markets, the crypto market has seen an explosion of interest in 2017 driving volatility to incredible highs and bringing along returns of hundreds of per cent. Therefore, no trader could have missed it as volatility is like a prey that all active traders are after. But the rise was so rapid that not everyone had a chance to participate. The continuing correction in the crypto market is an opportunity for everyone to get prepared and not miss new chances that this market will offer in the future.

Although different markets share many similarities, a trader should consider certain specifics that he will face when switching to crypto trading. Below we discuss these specifics.

Similarities between Stocks and Cryptocurrencies

Market Psychology

Any market is driven by the balance of buyers and sellers, by their expectations and emotions. Human psychology and the accompanying behavior patterns are here to stay. You don’t have to be a technology expert to start trading cryptos: price action is of the highest value and interest for traders, i.e. the chart, quotes, newsfeed, and consistent patterns; and therefore, pattern trading is applicable in this market as much as in any other market. And also you don’t have to believe that cryptos and blockchain will conquer the world: the most important point is that there is a crowd whose faith may fluctuate quite wildly driving strong movements in both directions.

News Effects

When it comes to companies, traders in traditional markets closely watch quarterly reports and forecasts published by analysts and the company itself as well as M&A rumors, reshuffle of management, new contracts, drug development updates (for biotechs), etc. In case of Forex and index trading as well as government bonds traders pay attention to central bank meetings, inflation and unemployment data, economic growth indicators, etc.

Cryptocurrencies have a different specifics but they also offer a great number of newsbreaks affecting coin prices in the same fashion as news affect conventional asset classes: new project launches, new coin listings, forks, partnerships, new products, and new technology development.

Most recently, the news of SEC considering crypto ETF proposals and Goldman Sachs postponing its crypto trading desk decision (which has been eventually refuted, but after the fake news hit the feed the market fell out of bed) were of high importance for the entire market. One has to follow news like that, observe price response, and make trading decisions.

How Cryptocurrencies Are Different

Volatility and Liquidity

As mentioned, volatility is the most obvious advantage. We saw a correction in the equity market at the start of this year, which shortly boosted volatility; however, it gradually returned to a fairly low level. And no one knows how long it will stay at the current level.

It is widely accepted that 20 is the threshold for VIX, above which the market is deemed really interesting for traders; but we’ve been below this figure since April. For cryptocurrencies, however, a price movement of tens of per cent in a couple of days is normal even in a calm market environment. In view of insufficient mass adoption, as soon as new capital enters the market amid low liquidity prices may rise very high, which is often unjustified fundamentally.

Compared to traditional financial markets, the crypto market has relatively small number of players and less money involved, and therefore, low trading volume. Due to insufficient liquidity, buying a large quantity of coins triggers sharp and rapid price movements resulting in the average purchase price being worse than expected. This market environment basically represents an advantage for small-size traders: to a large extent, it brings higher volatility. Everything is much faster in the crypto market: the growth cycles give way to decline cycles much more frequently, and everything seems to be a fast forward play vs conventional markets, which means money can be made (as well as lost) much faster here.

Regulations and Investor Protection

Legislators lag behind the crypto market development. Investors can feel relatively safe in the traditional markets: brokers are licensed and controlled by the regulators. Crypto exchanges, however, are unregulated, and therefore investors have no protection whatsoever. Although cryptocurrencies were initially meant to make its users independent from the government, in this particular case weak regulation is rather a drawback. No one has yet taken any responsibility for fraud, fake transactions, insider trading, and manipulations in the cryptocurrency market, which gives edge to con artists over other traders. If a company that issued tokens decides to run off with cash, investors have no legal protection.

Although fraud can also occur in traditional markets, owing to stricter controls it is rather an exception than the rule. That is to say, a regulated market is meant to provide access to assets that have been rigorously filtered. And therefore, a trader can open a chart and start trading with the understanding that what he/she sees on the chart is an actually operating company or an existing asset (we are referring to the stock market, rather than some pink sheets). In this regard the crypto market is nothing alike. That is why, traders have to be extremely careful when picking assets to trade and much more thoroughly study and research target companies as well as the management team, and background and experience of its members in order to avoid outright fraudsters.

Regulators, and first and foremost the SEC, have been closely watching and studying the crypto market recently while getting ready to establish decent supervision and control over the space. Issuers of tokens will be subject to more strict regulations as there are ever more security tokens the turnover of which is controlled by the government, which, in turn, will solve the insufficient regulation problem. In addition, more and more companies realize that issuing tokens is much cheaper and easier than issuing stock or bonds as the former eliminates middlemen, depositaries, underwriters, and other bureaucratic formalities alike.

Fundamental Valuation

In case with traditional assets, and in particular those traded in developed markets, there are public companies available in virtually every industry that one could compare valuations against in terms of various financial indicators and ratios. There are no strict and defined models available in the crypto market using which a trader could project future currency prices. In addition, new projects are hard to assess for that matter as they represent new technology that has yet to be launched or reach mass adoption.

There is also no information deficit in the traditional markets: all issuers are required to regularly file financial statements, make projections as well as update supervisory authorities on all material changes; governments publish official statistics, and an army of analysts compete in making forecasts for the majority of assets. All of the above helps investors review outlook for their investments in a particular asset.

A similar environment is just starting to form in the crypto market, which makes selecting cryptocurrencies for investing harder. One should carefully pick its information sources as there is an ever growing number of fake pundits who, while themselves having weak understanding of the technology and market, try to make money off of newbies who have no clue whom to trust. The crypto community almost exclusively uses Twitter and Telegram for communication. We already covered Twitter accounts worth following in one of our previous articles:

Read on Medium: Top 50 Blockchain and Crypto Twitter Accounts to Follow

Exchanges and Trading Platforms

The overall technical aspects are far from perfect too. Trading platforms are technologically deficient and inconvenient for active trading. Orders, as the platform itself, can freeze and stay inactive. Multiple open charts look awkward, and therefore one is forced to use third-party charting solutions. To some extent this flaw can be remedied by longer-term trading where seconds and fractions of a percentage point are not critical.

In case of a system failure in the traditional market, an exchange can review the incident and cancel specific trades. There is nothing like that yet in the crypto market, which increases risks for traders.

Technical support is also a problem: if a user faces troubles (incorrectly entered address or a frozen order), she is very unlikely to get a response from the support team. Another difficulty

is the ever more complicated and lengthy verification procedure: sending documents in, long waits, and during periods of peak demand in the past exchanges refused to accept new clients altogether or set high minimum deposit requirements.

In addition, exchanges may be targeted by hackers. Cryptocurrency transactions are irreversible meaning that it is impossible to cancel a transfer even if it was made by a fraudster. In some cases exchanges may make up the loss, but there are no guarantees in this regard whatsoever. This is why, one should be very careful when picking a crypto exchange; we advise against depositing large amounts with a single exchange, even if that exchange is the most secure one, and recommend diversifying across multiple exchanges and transferring long-term crypto investments to cold wallets in order to reduce exchange compromise risks.

Trading Hours

Traditional exchanges are open for trading for a limited time. While you can trade futures (and Bitcoin futures too) on CME Globex and currencies on Forex virtually 24/7 but with weekends off, stock exchanges are open on weekdays only and close in the afternoon. Activity and trading volume are significantly lower during non-operating hours.

Cryptocurrency exchanges are open 24/7/365 — no days off or clearing breaks, therefore a crypto trader always has access to the terminal and can make place a trade at virtually any time. On the one hand, it is a big advantage as you could choose any period for trading that suits you best, be timezone independent, and combine trading with another job, if desired.

It may also be a problem, on the other hand: the more active the trader, the more time he has to spend in front of the screen to not miss the perfect timing for entering or exiting a trade. It would be wiser to trade larger time frames to take time to rest and rejuvenate and to be less affected by smaller-scale fluctuations.

A Great Deal of New Instruments to Trade

The crypto market is very young, and therefore, new instruments are continuously born here. And as they are new, they are more likely to be less efficient vs conventional assets that have been trading for many years by the same traders, by robots, and market makers. Meanwhile, we are witnessing the dawn of an entirely new market: new token derivatives will be created and all this taken together will provide additional volume for trading, investing, and hedging operations.

Infancy of the market also means the many coins were listed just recently and traders have insufficient historic data for analyzing and testing their strategies.

Risk Management

Risk assessment is always the most important part of the business, and it is particularly true for cryptocurrencies in view of all the above challenges. Risk management in cryptocurrency trading ought to be more strict than in traditional markets for both individual trades and total capital used in crypto trading. Stocks and currencies also exhibit sharp and unexpected price moves, of course, but more often than not, such moves are exceptions. A 5% to 10% daily change in the top coins is a non-event. It is also important to always add a significant margin when assessing risks as it may be much harder to exit at the planned price due to insufficient liquidity.

In addition, while the only risk a stock trader takes is his trading losses, a crypto trader also bears infrastructure risks, and therefore, the crypto trading capital should be much smaller than the capital used for stock market trading. The principle stays the same: do not trade with money you can’t afford to lose, and this rule becomes really crucial in the crypto market.

Conclusion

In view of the above, crypto trading is not hard or complicated for traders, and for experienced traders in particular: take crypto specifics into consideration and control your risks. The infrastructure will inevitably improve over time.

As for us, using our experience and knowledge acquired over the years of active financial markets trading, we will do our best to make this transition as comfortable as possible since our crypto exchange was created by traders for traders. And this is exactly why, the interface of UT Exchange will look familiar to you, and you’ll be able to trade safely and comfortably just as you would in a traditional financial market.