Over the past two years, the subject of cryptocurrencies has been gaining staggering popularity and interest among investors. At the forefront of this conversation, Bitcoin has been a trailblazer in the way people are starting to make transactions and interact with financial markets.
Exploding on to the financial scene in 2013, Bitcoin saw its prices surge from under USD15 to close to USD1,000 in a short span of time, and subsequently rising to more than USD2,500 today. This rise in prominence and volatility has led to greater interest among traders as they look to capitalise on the price swings in it.
However, whether you are an experienced trader or an investor looking to also trade this virtual currency, there are important things you first need to know before you starting trading.
#1 You Don’t Own The Underlying Asset When You Trade
Unlike investing in Bitcoins where you own the underlying asset in a Bitcoin wallet, trading Bitcoin CFDs does not require you to own the underlying asset and there will be no delivery of Bitcoin only the difference in the entry and exit prices of the CFD contract which is denominated in USD will be paid out.
For example, when you trade Bitcoin CFDs using a broker like IG, you are entering into a Contract For Difference (CFD) with the broker. This allows you to go long (if you think the Bitcoin prices will increase in the future) or short (if you think the Bitcoin prices will decline in the future).
In essence, you do not actually need to own any Bitcoins to profit from it.
#2 Who Is Your Counterparty?
When it comes to trading, you should always know the counterparty that you are trading through. A counterparty in a financial trade is the entity that is required to meet the contractual obligations of the trades you have made.
For example, if you enter into a short position in a Bitcoin CFD trade, you will make profits when the benchmark price of Bitcoin goes down. That profit will be paid to you by the counterparty that sold you the position.
Though few and far between, default risks arising from counterparties do exist. That’s when a counterparty is unable to meet its financial obligations to pay you and others.
To reduce this risk, you should always use a reputable and established broker when trading who is also acting as the counterparty to your trade, and not simply the one that offers you the lowest transaction fees.
#3 Understand That You Are Trading Based On Volatility
Never confuse trading with investing. When you trade, you are more interested in the short-term price fluctuations of an asset rather than its long-term prospects.
Volatility, rather than stability, is what you are seeking. Hence, you should make it a point to understand the characteristics of the assets you are trading.
Take Bitcoins for example, with the meteoric increase in its price over the past few months, interest has spiked, thus further increasing volatility.
#4 Currency You Are Using To Trade Bitcoins
The US Dollar (USD) is typically used to trade Bitcoin CFDs but it’s not the only currency that you can use for trading. For example, a broker may allow traders to buy and sell Bitcoin CFDs in a number of currency pairs.
#5 How Much Leverage Should You Use?
Trades are almost always made using some form of leverage. As such, it’s imperative that you are familiar with your financial position whenever you trade.
For example, if you are trading Bitcoins using USD, you will require a margin of 20%. Hence, you will need to maintain an account balance of at least $2,000 in order to trade $10,000 worth of Bitcoin CFDs.
That doesn’t mean you should only have $2,000 in your account. Rather, you need to cater for the possibility that the trade may go against you, hence reducing your account balance.
#6 What’s The Spread You Are Paying?
Similar to buying stocks, there is a spread involved for the buying and selling of financial assets. With all things being equal, you pay a higher price for Bitcoins when you are buying it, and receive a lower price when you are selling it.
This spread acts as a form of transaction cost. You should find out the expected spread that you would be paying before you make any trade since this will eat into your total returns.
#7 Funding Cost For Holding Overnight Positions
When you trade Bitcoins, you are trading based on margin. This means you incur a funding cost when you hold positions overnight. You need to remember to take funding charges into consideration when you hold positions over a period of more than one day.
#8 Bitcoin Trading Is Currently Not Regulated In Singapore
For Singapore traders, it’s important to note that Bitcoins are not legal tender currency in our country. As such, they are currently not governed by any regulations.
Investors or traders who hold Bitcoin positions are not able to seek recourse from the authorities in the unlikely event that there is an issue with trading in Bitcoins or derivatives on Bitcoins.
#9 You Are Not Trading A Currency. Neither Are You Trading A Commodity
Unlike fiat currencies (currencies which are legal tender and backed by a government), Bitcoin’s performance is not tied to any one economy, nor can they be directly controlled by central banks. This makes them more independent than currencies, which could be affected by external factors.
And while Bitcoins are created through a process known as digital “mining”, they are completely virtual, as compared to other commonly traded commodities.
#10 Risk Management Is Key
When it comes to trading Bitcoin CFDs, risk management is extremely important. A large part of the reason is due to the fact that Bitcoin trading, as of today, is generally seen as largely speculative and hence there is a lot of volatility in Bitcoin prices. That means while the opportunity to make profit is present, the risk are much higher as well.
To manage risk, Bitcoin CFD traders should always ensure that all their positions have guaranteed stops. This would prevent them from losing more than they have set aside, or in adverse circumstances, even chalking up losses that exceed their deposit.
Understand Bitcoins Before You Start Trading
As with all types of financial products, it’s always important to understand the product that you are investing or trading with before you get started. Leveraged trading brings with it an addition layer of risk and responsibility since you will be using borrowed money to make your trades. So make sure you are fully aware of how Bitcoin CFDs trading works before you get started. A demo account could be one way to gain experience first without taking actual risk.
- Bitcoins are NOT legal tender currency in Singapore.
- The trading of derivatives on Bitcoins is NOT currently covered under any regulatory regime in Singapore.
- The customer cannot seek recourse from the Monetary Authority of Singapore (“MAS”) nor the Financial Industry Dispute Resolution Centre (“FIDReC”).
- Please ensure that you are fully aware of the risks and if in doubt consult an independent financial adviser. For more information on Bitcoins, please refer to the following website for more information: MoneySense – Virtual Currencies.