Basic concepts in trading

In this article, our team will cover the essential notions in trading and highlight the key principles of this discipline, aiming to enhance your understanding and effectiveness in the trading process.

• Drivers of asset price changes and market volatility
• Market makers and retail traders
• Trading volume and liquidity
• Crypto/currency pair, bid, ask, spread, and order book
• Slippage
• Types of trades and order types
• Locking in trade outcomes
• Spot trading and futures
• Timeframes and candlesticks
• Technical and fundamental analyses
• Trading algorithm

Drivers of asset price changes and market volatility

On a general level, all assets adhere to the basic laws of economics. Price growth occurs when demand exceeds supply, and conversely, the price of an asset decreases when the opposite situation arises.

Price changes occur as a result of the ongoing battle between buyers (bulls) and sellers (bears) in the market. The direction of an asset's price is determined by the dominance of either the bullish or bearish sentiment at a specific moment in time, based on the volumes of capital being invested by each group.

In practical terms, imagine that the asset's price has reached $10. The direction of future price movement will be determined by the relative volumes of buying and selling activity at the current price, reflecting the actions of both bullish and bearish traders. If the buying volume at price $10 exceeds the selling volume, the price of the asset will rise, and vice versa.

Volatility refers to the ability of an asset to change its value per unit of time under the influence of market participants. Consequently, the more volatile an instrument (asset) is, the greater opportunities for profit per unit of time are available to the trader. On the contrary, the lower the volatility, the fewer opportunities the trader has, and the more time it takes for the asset to undergo a relatively significant price change.

If we are not discussing long-term investments but rather short-term and/or medium-term speculative operations in the market, the asset's price, its direction of movement, and the current market phase are essentially irrelevant. The crucial element that determines a trader's opportunities is volatility.

Market makers and retail traders

There are two driving forces in the market: market makers and retail participants.

Market makers (MM), commonly associated with institutional structures (such as banks or large funds), that manage substantial government and/or private capital. They have the most significant impact on asset price behavior. Essentially, market makers act as puppet masters, manipulating the market by hunting for liquidity.

Retail traders are smaller-scale market participants who engage in investment or speculative activities with various assets. In general, retail has a significant influence on the market due to its operation with substantial aggregate volumes. However, in terms of influence, it is incomparable to the impact of market makers. Therefore, market makers frequently determine the market's state of affairs, while retail traders either align themselves with the market maker's direction and generate profits or go against it, becoming a source of liquidity for the market maker.

MM can manipulate charts by adding any things they need. The lower the daily trading volume (daily circulation of funds) in an asset, the easier it is for MM to influence the price because they would need to utilize a smaller amount of capital for this purpose.

Trading volume and liquidity

Trading volume is the metric that represents the sum of the volumes of all completed transactions in the market for a specific asset over a defined period of time. This metric is directly related to liquidity. Basically, the higher the daily trading volume of an asset, the higher its current liquidity.

Liquidity is a dynamic property of an asset that indicates how easily and smoothly it can be converted into cash at a price that is closest to the market value.

Trading volume is important when you are dealing with a large amount of money or a substantial quantity of assets because high liquidity ensures that your market orders are more likely to be executed at the desired price without significant obstacles. In the case of low liquidity, you may encounter situations where the price of an asset reaches your order price but fails to execute, after that the price changes its direction and triggers your stop loss. In such case, neither you nor your algorithm made any mistakes. In this situation, the loss would be caused by a situational lack of liquidity in the traded asset.

Besides the speed of order execution, high trading volume acts as a filter for market makers. The higher the value of trades conducted for an asset within a specific time period (such as a day), the more capital is required MM to influence the asset price.

Crypto/currency pair, bid, ask, spread, and order book

Crypto/currency pair is a structural unit in exchange trading that represents the ratio between two currencies and indicates how many units of one currency are cost another currency. For example, in the BTC/ETH pair, BTC is the base cryptocurrency, while ETH is the quote currency. Therefore, the currency pair shows how much quote currency is needed to buy one unit of the base currency.

Bid is a demand price and represents the highest value that a buyers are willing to pay for an asset at the moment.

Ask is an offer price and represents the lowest price at which a holder is willing to sell their asset at the moment.

Spread is the difference between the Bid and Ask prices, which represents the gap between the maximum price at which market participants are willing to buy the asset and the minimum price at which the market is willing to sell it.

The order book, also known as the market depth, displays a list of buy and sell orders (Bids/Asks) for a traded asset. In the order book, sell orders are typically located at the upper part, while buy orders are located at the lower part. Orders are executed in the order of their arrival in the book, based on their price. For example, if you place a sell order at $100 and it is the 50th order in line, it will be executed only after the preceding 49 orders at that price have been executed.

Slippage

Slippage is a term used in exchange trading to describe the phenomenon when a trade is executed at a price that differs from the trader's expectations. It is a common occurrence in assets that have high volatility and/or low liquidity at the moment.

Let's imagine that you placed a market order to buy an asset at a price of $100. This is the highest price at which you are willing to purchase the asset. However, due to low market liquidity and high volatility, the price exceeds the $100 mark and reaches $101. Since, at that moment, this price is the best available in the market, your orders will be filled at this price until all your orders are completed. As a result, it is possible that some of your buy orders will be executed at $100, while others will be executed at $101. This means that the average purchase price of the asset will be higher than your initial plan of buying at $100.

To minimize the impact of slippage in trading, it is important to select highly liquid assets with large trading volumes and utilize order options effectively.

Types of trades and order types

There are two types of trades: Long and Short.

Long - a type of trade in which an increase in the asset price is expected. Accordingly, the price targets for such a trade will be above the trade entry price.

Short - a type of trade in which a decrease in the asset's value is expected. In a short trade, the price targets on the chart will be below the entry price. Short trades are primarily executed in the futures market.

Order - a market request or instruction created by a trader to execute buying or selling operations on an exchange.

Market Order - a type of order that executes your buy or sell request at the current market price of the asset. By selecting this type of order, you need to specify the amount of funds for the transaction and click the button corresponding to the desired direction of the trade. After selecting the direction, your order will be instantly executed at the best available price for the asset at the particular moment.

Limit Order - a pending buy or sell order for an asset that will be executed when the price reaches a specific value.

1 - In this field, you specify the price at which the order should be executed.

2 - In this field, you indicate the amount of funds that will be involved in the transaction.

After filling in these fields, you need to click the button corresponding to the trade direction (Buy/Long or Short/Sell).

Stop Limit Order - is a more advanced version of the previous type of order.

1. In this field, you specify the price level that "activates" your order without executing it. Until the specified price is reached, the order remains inactive.
2. In this field, you set the price at which your order should be executed, allowing a slight difference between fields 1 and 2 to minimize slippage.
3. Enter the amount of funds that will participate in the trade in this field.

Select the trade direction (Buy/Long or Short/Sell) to finalize the order creation.

Locking in trade outcomes

You should always remember that regardless of the direction of the trade, the asset you are trading, the duration of the trade, and the unrealized profit you had at any given moment, the effectiveness of your trading is defined by the points where you lock in your results. It is these points that convert your "virtual" profit or loss into reality.

You can see your "virtual" or unrealized profit at any given moment in the corresponding section of the open trade. It will dynamically change as the asset's value fluctuates.

Take Profit and Stop Loss determine the points of result locking.

Take Profit (or TP) is the level at which the trader sets to lock in profits. It is placed at specific price levels, and when those levels are reached, the trader either reduces the trade size to secure a portion of the profit or closes the trade entirely to capture the entire profit.

Stop Loss (or SL) is the level at which the trader sets to limit losses in a trade. It is placed to minimize losses if the price moves in the opposite direction of the trader's expectations. When the price reaches the Stop Loss level, the trade is closed to prevent further losses.

There are two options for setting TP: within the position line and in the order management menu.

In the position line, there is a button to access the Take Profit and Stop Loss management menu. Within this menu, you have the option to set TP and SL for the ENTIRE position. This menu does not allow for partial take profit or partial profit fixation.

1. When the price reaches the set TP level, the trade will be fully closed and the profit will be locked in
2. Automatically calculates the potential profit when TP is reached
3. When the price reaches the set SL level, the trade will be fully closed and the loss will be locked in
4. Automatically calculates the potential loss when SL is reached

Press the button to confirm and activate the configurations.

In the specific example, you have two possible outcomes for this trade: a profit of $910.32 or a loss of -$1365.47. The trade will be closed automatically and no additional steps will be necessary on your part.

You don't need to constantly monitor the chart or track the price movement of the asset or set up a notification for target achievement on TradingView. You can simply wait until you receive a notification that the trade has been closed.

You can also set partial profit-taking levels for your trades. It doesn't matter whether you are using a limit order or a stop order. What's important is to activate the "Reduce-Only" option, which allows only position reduction. After enabling this option, you need to specify the price at which you want to fix the profit and indicate the percentage of the current trade to be reduced upon reaching the TP level. Finally, you can finalize the order by clicking the Buy/Long or Sell/Short button.

The maximum number of TP levels for a trade is unlimited, but it should strictly adhere to your trading plan.

Spot trading and futures

Generally, spot trading and futures trading are the two most popular types of trades in the cryptocurrency market. These trading methods differ conceptually from each other and have their own advantages and disadvantages. We have described both types of trading in a separate article, which you can find at the following link: https://teletype.in/@pfi_team/spotvsfutures_eng

Timeframes and candlesticks

Timeframe (TF) refers to a specific time period during which price and other market data are aggregated to construct a chart. The movement of an asset on the chart over a given time period is represented by a Japanese candlestick (although there are alternative methods for displaying price aggregation, in this article we will focus only on Japanese candlesticks because they are the most widely used and convenient form of data representation).

The color of a candle is determined by the difference between its opening and closing prices. If the closing price is higher than the opening price, it indicates an increase in the asset's price and the candle is colored green. If the closing price is lower than the opening price, it indicates a decrease in the asset's price and the candle is colored red. The candle's shadow indicates that the price reached certain price levels within the current TF.

A candlestick of a higher TF contains multiple candles of lower TFs"within" it. Therefore, the lower the TF, the more data is provided on the chart. On the other hand, the higher the TF, the more reliable the data is considered and there is a greater probability of its effectiveness or execution.

Above is a visual example of how the same section of a chart for the same asset looks like over a 10-day period, but using different TFs.

Technical and fundamental analyses

Technical analysis is a collection of tools used to forecast potential price changes based on patterns and trends observed in historical price data under similar circumstances.

In other words, it is a framework for analyzing asset price charts using specific indicators and tools to identify patterns and trends, which can help forecast future price behavior.

Fundamental analysis is a term used to describe methods of predicting the market value of a company based on analyzing its financial and operational indicators. Unlike technical analysis, it explores and takes into account a broad range of factors, including the company's financial statements, industry outlook, potential growth prospects, political and social factors, and more. Traders develop their forecasts by studying and evaluating macroeconomic (overall economic conditions) and microeconomic (company's earnings, profits, equity) factors.

Within the scope of this article, we will not delve into the study of either technical or fundamental analysis. Firstly, these are incredibly vast topics that have been extensively covered in numerous books. Secondly, our indicator users do not need to spend years studying these complex subjects.

Trading algorithm

The market has been providing money-making opportunities for decades on a daily basis and these opportunities will always exist. The question is whether you will be able to seize them. At first glance, trading may seem fairly understandable and even quite simple. However, the euphoria of potential "easy" money can quickly turn into pain after experiencing significant financial losses. That's exactly how trading educates market participants, but not everyone will be able to convert such "education" into money. Perhaps trading is the most difficult way in the world to earn the easiest money. Here, it's easy to achieve situational success and believe in one's abilities, but it's very difficult to become a successful long-term trader. The only way to achieve this is by developing a brilliant trading algorithm that contains a detailed set of clear rules for actions in various market situations. It will be necessary to carefully test it on a large retro period to ensure its effectiveness. And when trading in real-time, one must fully adhere to it without succumbing to emotions that will accompany the trader's career. Undoubtedly, those persons who have truly acquainted themselves with this form of earning money fully understand how challenging it is. For many of them, it is so difficult that they abandon it after a series of financial losses, deeming it "hopeless." And indeed, this is the case if you work without an effective algorithm.