Understanding the Basics
In this chapter, you’re going to take a risk assessment questionnaire so that you can better understand yourself and be able to handle the emotions you’ll encounter when trading. Next, I’m going to share with you a candlestick story so that you’ll take your first steps in studying a chart on various timeframes. After that, I’m going to share with you how different market participants trade so that you can better understand the market environment and why suddenly one of them buys a token, even if all the indicators show it should be sold. Finally, you’ll learn about the three types of markets and what makes them different.
My goal for this chapter is for you to get to know your risk level and to find out more about the entities that trade alongside you.
Here are the topics we’re going to talk about:
- A trader’s psychology
- Understanding risks
- Cryptocurrencies as an asset class
- A candlestick story
- Market participants
- Types of markets
A trader’s psychology
In this section, you’ll complete a risk assessment questionnaire and learn about the three types of traders to determine which category you fall into. Based on your responses, you’ll gain insight into potential risks you may encounter while trading and how to address them.
Risk assessment questionnaire
Answer questions 1 to 10 by choosing the answer that’s most related to your current situation (or what you’re most likely to do in the situation provided). Ignore what you think you’ve learned after reading the question (what you should do) and focus on what you would do:
- How would you be characterized by your best friend?
- Willing to take some risks
- Choose your prize:
- $1,000 cash
- 50% chance of winning $5,000
- 10% chance of winning $15,000
- The price declines by 50%. What’s the percentage it needs to increase to arrive at the same level as before?
- What win rate do you need to break even (getting $0 in profit) for trades with a risk-reward ratio of 4:1 (for every trade you risk $1 to win $4)?
- What does risk mean for you?
- What would you do with $1,000?
- If you had $10,000 to invest for 10 years, which option would you choose?
- Low risk, low return
- Medium risk, medium return
- High risk, high return
- When the market goes down, what would you do?
- Do nothing
- Double down
- Sell riskier assets and buy safer ones
- If you left $1,000 in a deposit with a 2% interest rate per year and inflation was 2% per year, after 1 year, how much would you be able to buy with the money in the account (without taxes)?
- More than today
- Less than today
- Exactly as much as today
- When making a trade with a strategy that has an 80% win rate, if you’re at a minus of 10%, what would you do?
Here are the scores for the answers to these questions:
Figure 2.1 – Scoring table for the answers to the questionnaire
For question 8*, it’s logic versus psychology. Doing nothing is what a low-risk investor would do, even though financially speaking, selling riskier assets and buying safer ones is what a low-risk investor should do. In my test, I’m biased toward psychological accuracy.
The gambler (score < 17)
What is life without a touch of risk?
You are a gambler at your core, and you actually know it. When you trade, your emotions run high, and you’re there, into the trade, living every high of it and dreading every low. When you win, you win. You smile and you think of all the future earnings that you’ll receive. And when you lose, you sure lose. You’ve already doubled down, and every loss hurts.
In my coaching business, I have a lot of gamblers who come and want me to teach them how to win when trading. When they see the work it takes, they ask for the best strategy or daily signals. And when I show them what’s the work behind creating and managing such a strategy, they have a choice to make. Either slow down hard or risk losing money before actual learning occurs.
The best advice I have for the gambler is to better understand their counterpart, the cautious trader. I invite you to do swing trading that is not micromanaged, to set trades that enter at a certain price and that exit at specific prices, be it at a loss or a win. Before each trade, you need to have a hypothesis (reasons for entering the trade and for exiting the trade at your chosen levels). Then, after the trade has run its course, you need to revisit your hypothesis and update it with the result.
In time, this will help the gambler in you create a distance between your emotions and the trades you are taking so that you can follow a strategy to its success.
And to also have a release for those emotions, you can either use another account or just mark your trades as #spontaneous and do those trades with a lower amount of money.
The cautious trader (score > 23)
I want to protect my money before I win anything.
You value your hard-earned money, and you know you’re not here for the easy win. Maybe you’ve already started studying the classics of investment literature; if not, you’re surely planning to and you are ready to put that money into some fruitful investments. You are a bit scared of losing them, especially in the cryptocurrency world where you’ve heard that there are big fluctuations, but you’re here to stay and to ride those waves for the win.
I don’t have a lot of cautious traders as clients, but when I do, I identify them instantly. From the first few minutes, they are telling me what’s important to them (variations of not losing money), and they are also making sure my credentials are intact (How much did you win? What types of strategies do you use? What’s the success rate of your clients?). They are trying to make sure that they’ve made the correct choice.
My top advice for (fellow) cautious traders is to dedicate money to losses. Not to risk, but to lose. Trading is an emotional game, and when you switch from paper trading to money-based trading, a lot of emotions will circle around you, waiting for that chink in your armor. In paper trading, it’s easy to start a trade and then wait for it to finish. In real trading, you’re enticed to always watch the charts and to make sure that your trade is working... So, what happens if the price starts falling? Should you exit early or wait for it to touch the price you’ve set as a stop-loss?
Here, the cautious trader’s brain freezes. There are too many variables, and they can look at reasons for the trade to end in profit, but they can also find reasons that the trade will fail.
In order to overcome all of those emotions, they need to accept risk as part of their trading career and learn to manage it rationally and predictably.
The balanced trader (score between 18 and 23)
Winning is a slow and steady process.
You have lived a life full of experiences. You know that winning involves risk, and you’re ready to put some money where your desires are. Yet you have a financial reserve that you will not touch, and that is there just in case you realize trading is not for you. You’re willing to give it all but also to analyze your results after a time and to decide if this is for you or not.
I have quite a few balanced traders as clients, and they are the easiest to work with. That’s because I can put the psychologist in me to sleep and focus on the mechanics of trading with them. Some catch the mechanics pretty quickly, some a bit later, and most of them leave when they have a few techniques that they can trade and when they understand that trading is like chess—easy to learn, hard to master. Sometimes, they come back when they need a technique automated or when they have some really advanced questions.
My advice for the balanced trader is to continue what you are doing. If you’ve got this score, your emotions won’t impede your trading that much, and you will be able to grasp the concepts and learn at the pace needed to keep your motivation and start getting results. And after you’ve got the results, everything else is just scaling.
Some final thoughts on risk assessment
Every type of person can fit in the trading space, but some have more challenges than others. Maybe a cautious trader progresses slower, but they also lose less money. During this time, the gambler might get some early wins, enough to push their motivation to learn the difference between trading and gambling. But they might also get enough early losses to make them leave the markets for good. And in all this time, the balanced trader progresses slowly and steadily, still wondering how all those people win so much. Each personality has its own set of questions and emotions that help or impede them when trading and its own battles on the money battlefield. All you can do is prepare yourself to the best of your abilities and then live your life as you want to live it.
We’ve identified what type of trader you are, and next, I’m going to show you who the other market participants are and how they behave in specific market types.
But first, let’s start with an answer to the following question: What exactly are currencies?
Cryptocurrencies as an asset class
A cryptocurrency is a digital currency, secured by a cryptographic algorithm that prevents double-spending and counterfeiting. Most of today’s currencies work on computer networks independent of central authorities such as governments or banks, eliminating the need for traditional middlemen and facilitating true ownership of funds and quick (almost instantaneous) transactions.
Even though they are named cryptocurrencies, they are not considered to be currencies in the traditional sense (though they are classified as commodities, securities, or even currencies). They are usually viewed as a distinct asset class and are theoretically immune to government financial manipulation.
By asset class, we are referring to the ability of the asset to hold value and have true use cases. The first cryptocurrency, Bitcoin, defined in a white paper that was published on October 31, 2008, has already proven its value-holding potential; its returns for the last 10 years have been positive, even with its high volatility. Its main use case can be considered fast and cheap transfers (through the Lightning Network) that work between any parties having a Bitcoin wallet, 24/7.
In this section, you will hear a candlestick story, followed by an overview of the different timeframes that traders use. We will also discuss the various market participants and how their trading affects the market, creating different types of markets, each with its own unique characteristics and trading style.
A candlestick story
Hey Siri, play “The Candlelight Story” by Tony Chen.
The God of Markets, Munehisa Honma, is said to be the creator of candlestick charts. He was a rice merchant from Sakata, Japan, who traded the Dojima Rice Market in Osaka, during the Edo shogunate. Stories are told about when he created a personal postal service (men spread every 6 kilometers over 600 kilometers) to get the market prices in time. In 1755, he wrote the first book on market psychology, San-en Kinsen Hiroku, or The Fountain of Gold – The Three Monkey Record of Money, in which he talks about traders’ emotions and how they influence prices.
In 1991, the candlestick appeared in the Western world in a book called Japanese Candlestick Charting Techniques, written by Steve Nison, who says that, according to his research, it is unlikely that Honma used candlestick charts.
So, the initial story might actually be the first trading urban legend in Japan.
But what is a candlestick chart?
Well... let’s first start with a candle...stick!
Figure 2.2 – A candlestick
A candlestick chart is a financial chart that shows the price movements of securities, derivates, or (crypto)currencies. It is also called a Japanese candlestick chart or a K-line chart. Each candlestick there represents four essential pieces of information: the price at opening time, the price at closing time, and the lowest and highest price of that timeframe. They are usually colored white or green for rising prices (Close > Open) and black or red for falling prices (Open > Close).
All images in this book are in grayscale, so there may be a slight adjustment period when you view the colored candles on TradingView.
So, with just one look, you can see if the price is rising or falling, by how much, and even what were the highest and lowest points it traded during that timeframe.
Here’s how it looks on a chart:
Figure 2.3 – A candlestick chart
This chart is also called an open-high-low-close (OHLC) chart (because you can see these values for each candle on the chart). To make it easier, we’re going to use the short forms for Open, High, Low, and Close (O, H, L, and C).
Here, you can see how the white candles (or green candles) show rising prices (C > O, meaning that the close price is greater than the open price; basically, it closes “higher”) and the black candles (or red candles) show falling prices (O > C).
Each candle on this chart represents 1 hour of price movement, and we’ll find out in the next section what exactly these timeframes are.
We know what a candlestick is and what a candlestick chart looks like, and now it’s time to understand how to represent price movements over large (or small) periods. Have a look at the graph shown in Figure 2.4:
Figure 2.4 – The Bitcoin Liquid Index (BLX); each candle is 1 month (logarithmic display)
In stocks, you can have gaps between candles because markets can open at different prices than when they’ve closed, but this doesn’t normally happen in crypto. Here, the market trades 24/7, so when you trade you can expect the close of one candle to be the price the next candle opens with.
Then, if a candlestick shows the OHLC values, the distance between the opening of one candle and the next opening is the time length of the candle. Based on how we configure the chart, we can have anywhere from 1-second candles to 1-month candles (and more).
A 1-hour candle starts at
:00 (minute zero) and ends at
:59 (minute 59), and these candles are displayed on the hourly timeframe (also called the 1-hour timeframe or 1H). A 1-day candle starts at
00:00 and ends at
23:59 and is displayed on the 1D timeframe.
So, 1 candle on 1D equals 24 candles on 1H because there are 24 hours in a day.
Let’s check this out:
Figure 2.5 – A daily candle
The candle in the middle represents the price for BTC on July 7, 2022, in the BTCUSD market on Bitstamp. Its values are O 20546, H 21847, L 20238, and C 21644 (as explained in the section titled A candlestick story).
Let’s look at this candle in the 4-hour timeframe:
Figure 2.6 – A range of candles on the 4H timeframe
Here, the vertical bars show the start of each day. Starting from July 7, 2022, we have 6 4-hour candles until the next day. The last candle (black) is at
20:00, signifying the range
The L of the 1D candle (20238) can be found as the lowest point in the range, at the L of the second black candle.
The 1D H (21847) and 1D C (21644) are both in the last candle of the 4H range.
If we draw a 1D candle over its 4H range, the result looks like this:
Figure 2.7 – The indicator used was HTF Candles by Prosum Solutions (author prosum_solutions)
Now, it’s time for you to play with TradingView and make sure you understand the different timeframes and how a higher timeframe (HTF) candle is composed of smaller lower timeframe (LTF) candles. In the next section, we’re going to talk about identifying the three types of markets that drive the cryptoconomy.
Let’s consider the following types of key market participants:
- Commercials—insurance funds, pension funds, hedge funds, and institutions: Their main goal is protecting their capital using a portfolio profile, and for this, they can go where the market goes. The current price doesn’t matter that much (for example, they need to have a percentage of their portfolio in Bitcoin by the end of the quarter, no matter what happens to BTC). And their entries influence the price of the cryptocurrency being traded.
- Speculators—(manual) traders, algorithmic traders: The price matters; they consider the risk of their entries and trade market anomalies. Their entries don’t usually influence the price.
- High-frequency traders—bots and other automations: They do 90% of the trading, having well-defined entries and exits so that they can get the highest profit with the least risk. These entries influence the speculators because they both have the same short-term objectives.
The following are the types of traders:
- Scalpers: Scalpers trade quickly, based on order flow. Trades can take seconds or minutes.
- Day traders: They start and finish the day without an open position, trading based on technical analysis and order flows. They don’t care about the fundamentals of the cryptocurrencies they trade because they exit quickly. The trades take minutes or hours.
- Short-term traders: These traders use technical analysis, followed by some fundamental analysis, and their trades last for 3 to 5 days (for instance, they trade breakouts).
- Intermediate traders/swing traders: They use a combination of fundamental analysis and technical analysis to trade. Their trades take days, weeks, or even months.
- (Big) Long-term investors: They use fundamental analysis, and usually, filling their orders takes time (days even). Their moves influence the market, and they start and stop trends with their entries and exits. They stay in trades for years.
In order to simplify the mentality we should have when trading, let’s imagine we have a smart opponent that we’re trading against. When we win, they lose; when we lose, they win. They can wear different hats at different times—sometimes the hat of a commercial; another time the hat of a day trader.
The question we should always be asking ourselves is this: Which of the hats are they wearing in the current market conditions? Now, I’m going to give a few examples, but if you’re new to trading, feel free to skip them now and come back later, after reading the book.
Here are some examples of situations, but remember that any interpretation is relative to the truth:
- If we see a big upper wick on a 1-second timeframe on a specific exchange (and not on other exchanges), we can consider this to be a big one-time exit that reflects the needs of a commercial and doesn’t necessarily reflect a trend in the market. Basically, someone sold a lot of currency there, and then the market participants corrected that move by buying the orders back. But if we see multiple wicks, we can presume someone is continuously selling at that price a very large order by splitting it into small orders. There, we can expect more selling pressure than when a single wick forms. Here’s an example:
Figure 2.8 – Big upper wick
- If a cryptocurrency continuously trades in a price range, moving to the top, falling back, rinse, and repeat, that might be a situation where automatic algorithms are feeding themselves in a loop. If we spot these in time, we can enter longs (long trades) when the price is low, sell at the top of the range, and enter shorts (going short or shorting) until the price comes back down. Here is an example (but a low volume one) with an 8% increase and decrease in price, with each candle being 1 hour. Just imagine trading that:
Figure 2.9 – Steady price range
- Key news announcements in crypto create market volatility. A lot of speculators are trading at that point to profit from the volatility, specifically commercials that want to execute big orders. They are trying to find the liquidity that they need to sell their orders to:
Figure 2.10 – Fed press conference impact
Types of markets
Here’s what they look like:
Figure 2.11 – A bull market
A bull market is characterized by the following:
- Positive news (called bullish news)
- A lot of big investments
- Money is thrown around (even in mediocre businesses)
You can’t usually identify the start of a bull market until you’re already in it.
Most people start trading during bull markets because that is the time when everybody is bombarded by optimistic news and the economy is strong enough that everybody has some money left to invest. But the problem is that latecomers are joining in right at the peak (or end) of the bull market.
And then, the bear market comes. Here’s how it looks:
Figure 2.12 – A bear market
A bear market is characterized by the following:
- Negative news (called bearish news)
- Few investments
- No money in the market or long periods without any big activity
After starting, newcomers are usually faced with a bear market where all the techniques that they’ve used to make money suddenly stop working. This is the point where they usually lose money and, after a while, leave the market.
A sideways market, also called a lateral market or a ranging market, is a period when the price stays within a certain range. If the period is lower than a few months, we can call it a sideways trend. Here’s a sideways market on the chart:
Figure 2.13 – A sideways market
People don’t usually talk about sideways markets, and that is mostly because there is either no particular activity there or because the news is polarized, creating uncertainty. You can also see sideways trends during long bear markets where a lot of market participants have left the field.
But why do we call them bull markets and bear markets? Imagine how these animals attack their opponents. The bull thrusts its horns up, throwing its opponent in the air, while the bear swipes its paws down, pushing its opponent to the ground. Here’s a depiction of this:
Figure 2.14 – Bulls versus bears
There are tips and tricks to trade each market, but for now, let’s focus on learning how to identify them. At the end of the chapter, there will be some exercises to help you do this.
In this chapter, I helped you identify your risk level and taught you about other market participants and how they behave in the market. We also discussed a bit about cryptocurrencies and timeframes and started reading a chart.
My goal was for you to get to know your risk level and to find out more about the entities that trade alongside you.
In the next chapter, we’re going deep—right into technical analysis, talking about TradingView, candle patterns, moving averages (MAs), the Relative Strength Index (RSI), and much, much more.
- After taking the risk assessment questionnaire, ask yourself (and write down) three things you’re doing to keep your emotions in check in real life. I know a couple that say that when they want to fight, they speak in pirate English. Think: “Ye be mighty pushy! Belay that!” ... or just use The Pirate Translator here: https://pirate.monkeyness.com/translate.
- Identify 3 daily candles in TradingView, then go to the 4-hour and 1-hour timeframe and look at the candles that formed them. See how the low of the bigger candle was formed using the low of the lowest candle in the group, how the high was formed, and so on. How does the price move inside that big candle? Is it going directly to the close? Is it pushing toward the high, then dropping to the low, then jumping to the close?
- Identify a big news event in crypto (which happened at a specific hour, on a specific day). Tip: You can look for big Fed announcements or a black swan event (such as the crash of FTX). Check on the chart how the price reacted to the news and for how long. Imagine the market participants getting fueled by the news and trading during those times. Which market participants were involved? What was their thought process?
- Go to TradingView and open the daily chart for BTCUSD. First, try to identify the periods I’ve shown you in the screenshots about the bear market and the bull market, and then, go to a lower timeframe (4 hours or 1 hour) and identify 2 bullish trends, 2 bearish trends, and 2 sideways trends.