How to Profit from Cryptocurrencies – Part 1

If you are ready to take more concrete steps to profit from cryptocurrencies, it’s time to consider in more detail how you are going to do it. Many people invest in the right assets at the right time, yet still end up losing money because they either don’t plan or, if they do, they don’t stick to it. There are three things you must decide to get started:

  1. How much should I risk on cryptocurrencies?

  2. What is my time horizon (i.e. should I invest for the long term or trade in the short term)?

  3. Which cryptocurrencies should I deal in?

You answer to one question might affect your answer to another, but let’s consider them one by one.

How Much Should I Risk?

Cryptocurrencies are an extremely risky investment. So risky that in fact, you should be prepared for the possibility that the value of ANY cryptocurrency could fall to zero or effectively zero before you would have a chance to liquidate your investment and get out. 

This does not mean that you should not try to profit from cryptocurrencies. In fact, investments that carry the most risk often carry enormous potential upside in excessive positive returns. All that means is that you should be aware of what you are getting into. You should also be aware that there is little point in anticipating a maximum potential loss of X% – your entire stake could go up in flames. In truth, you must be prepared to lose every penny you invest in cryptocurrencies in a worst-case scenario. So, the question “How Much Should I Risk?” becomes “How Much Can I Afford to Lose?”.

Savvy investors typically dedicate a certain portion of their liquid, investible wealth to risky investments and the remaining portion to safer investments. For example, you could park 85% to 90% of your liquid wealth in an extremely safe investment such as an interest-bearing account at a major insured bank, or ideally U.S. Treasuries, and dedicate the remaining 15% to 10% to more risky investments, and use fractional money management in position sizing. Due to the exceptionally volatile nature of cryptocurrencies, you may want to ensure you don’t put all your “risky” investment fund into cryptocurrencies, just to be on the safe side.

There are two methods you can use to make your operation less risky:

  1. If you choose to invest, you can invest in more than one cryptocurrency. This diversification should reduce your overall risk.

  2. If you choose to trade, you might use a broker offering guaranteed stop losses, and trade such small quantities that you are effectively not leveraged or even de-leveraged.

What is My Time Horizon? Should I Invest or Trade?

You need to decide how long you are prepared to wait for potential profits, and how much of your time you are able and willing to devote to your operations. The answers to these questions will decide whether you should be a “trader” or an “investor”. If your timeframe for an in-and-out deal is minutes, hours, or a few days, you are probably better off trading cryptocurrencies through a brokerage, and considering yourself a trader rather than an investor, if you can cope with trading. If you are prepared to stay in the deal for weeks, months, or even years, then you are an investor. There are advantages and disadvantages to being either a trader or investor which you should consider before deciding which path is right for you:

How to profit

In some situations, these differences are a little unclear, so it is useful to look at a couple of real-life examples.

In Case A, Mr. Investor decides that he wants to benefit from a potential long-term rise in price of several cryptocurrencies: Bitcoin, Ethereum, Ripple, Litecoin, and Monero. He invests equally in all of them, with a total investment of $5,000, while understanding that it is a very risky investment, and that he might lose all or almost all that amount. He opens an account with a cryptocurrency exchange where all these currencies can be bought and sold, deposits $5,000, and then purchases $1,000 worth of each of the currencies at their current market value. He pays a commission of 5% on these purchases to the exchange, which he accepts as the cost of doing business. He plans to cash out his entire investment in 2 years no matter its value, and will cash out the investment in any single currency which rises in value by 1,000% before the 2-year time limit is reached. He checks his portfolio on a weekly basis and tries not to think or it or worry about it, accepting its value will fluctuate strongly.

Mr. Investor does not want to be a trader, for several reasons: he wants to deal in Monero, which is not offered by any major brokerages now. He also has a long-term time frame, and does not want to spend much time managing his investment. A few minutes each week is all he will need to be a long-term investor.

In Case B, Ms. Trader likes to check the market four times each day to decide whether to buy or sell various assets – she is a swing trader. She sees that the larger cryptocurrencies such as Bitcoin and Ethereum are attracting a lot of interest, and moving in strong, volatile trends, and thinks that these are markets she wishes to be involved in. She opens an account with a broker offering trading in Bitcoin and Ethereum, and deposits $1,000, a small fraction of her liquid wealth. Using her own analysis as a discretionary filter on top of a complete trading strategy, she buys and sells Bitcoin and Ethereum when she thinks they are more likely to go up or down over the next day or so. She risks only 1% of her account value per trade and uses hard stop losses which are wide enough to accommodate the high volatility of these instruments. She tries to take profit on winning trades when they are in profit by at least 3 times the amount or the risk of the trade, and sometimes leaves part of winning trades open in the hope of riding very strong trends for even greater profits. She can profit from correctly anticipating decreases in value, as well as price increases, as brokerages allow short selling, as well as long trades. She pays a commission to the broker in the form of spread differentials when she enters and exits each trade. She also pays a fee on each open trade every night, which encourages her to close most trades within only a few days from their open. She hopes to double her initial deposit within 6 months to 1 year, but she accepts that using non-guaranteed stop losses means that in the event of a price crash, she could lose most of her account in a matter of seconds. For this reason, she is very interested in the possibility of buying options on Bitcoin and Ethereum, which should become available later in 2017 or 2018.

Ms. Trader does not want to be an investor, as she feels that as a skilled trader who is already spending time monitoring markets every few hours during each day, she may as well add the major cryptocurrencies to her list of assets to watch. She also believes she can make more profit in a shorter amount of time than she could by making a long-term investment.

These cases should hopefully give you an idea of whether investing or trading is likely to suit you better. Which type of strategy and lifestyle do you relate to better? It is almost certainly true that if you have not traded already, it is better to become a long-term investor. If you are not already a competent trader in other assets, you are extremely unlikely to make more money trading the major cryptocurrencies than you would by investing in them. As investing is likely to be the way to go for most, the next section will explain the “how” of investing in cryptocurrencies, and the section after that will do the same concerning trading cryptocurrencies.

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