As soon as day traders realized that Bitcoin may be here to stay, a large number of them decided to start trading bitcoins on various Bitcoin exchanges. Although the early days of Bitcoin were plagued with plenty of scams where exchanges or wallet providers would run away with the bitcoins overnight, the reality is that we are now looking at a much more mature market for trading bitcoins.
Whether you’re looking to enter your trades manually or have some bots do all the work for you, it’s important to understand how Bitcoin trading actually works before you dive into the deep end.
Choosing a Bitcoin Exchange
The first thing you need to do when you want to learn how to trade bitcoins is figure out where you’re going to be doing your trading. Although this is supposed to be a decentralized, P2P currency, the reality is that it’s currently impossible to do high-frequency trading without the help of a centralized server. These centralized servers have been known as a point of weakness for the Bitcoin market as a whole, but improvements in security have slowly been rolled out to various exchanges over time.
If you’re going to trade bitcoins on a regular basis, then you’ll need to have some deposits at one or two Bitcoin exchanges at all times. While platform features and unique trading options may be the most important aspects of exchanges in other markets, the reality is that security is the most important feature to think about when trading bitcoins in a hot wallet. Factors such as longevity, two-factor authentication, and proof-of-reserve are going to be the most important features to look at when choosing an exchange.
Longevity and two-factor authentication are two factors that you probably have in the back of your head for traditional exchanges, but proof-of-reserve is a new feature for Bitcoin exchanges that should be viewed with the utmost importance. Bitcoin exchanges are able to prove that they actually have the bitcoins they say they have by signing messages from Bitcoin addresses containing large amounts of bitcoins, so this should calm some of your fears when it comes to the possibility of an exchange running a Ponzi scheme. Certain exchanges that offer proof-of-reserve, such as Kraken and Bitstamp, should be at the top of your list.
Buy and Hold Bitcoins?
Once you’ve signed up for a Bitcoin exchange and verified your account, you can then start to think about your own trading strategy. There are plenty of traders who try to time the market on a daily basis, but the reality is that the buy and hold strategy is the one that has paid off for the largest number of Bitcoin holders in the past. You never know when a piece of regulatory news out of China or a newly announced killer app could cause a huge price swing one way or the other, so it’s usually a good idea to throw your emotions out the window and simply purchase bitcoins on a regular basis. This will be weekly for some traders, while others will decide to pick up a few bitcoins on the first of every month.
Attempting to trade bitcoins without understanding why you purchased them in the first place can also be a huge issue. Bitcoin has been known to drop in price by as much as 50% in a single day, so you cannot be tempted to exit the market at a loss when these kinds of events take place. Trading bitcoins without a view that the price will eventually go higher as the price increases can be problematic due to the fact that you will probably end up buying high and selling low.
Report Your Profits
One last thing to remember when it comes to trading bitcoins is that this currency is not really anonymous when you’re using a centralized exchange. After all, the exchange knows all about your true identity due to the various AML and KYC regulations they are all required to follow. Having your bitcoins increase in value in terms of dollars is not something that will be easy to hide from your local government during tax season. These earnings are viewed as capital gains in most countries, so you should remember to fill out your yearly tax return with that fact in mind.