An introduction to cryptocurrency trading and how it works

Blockchain basics: how the technology enables cryptocurrencies

To understand cryptocurrency trading, it is essential first to comprehend blockchain technology. A blockchain is a distributed ledger that records information in blocks linked chronologically by cryptographic functions.

This design makes historical records resistant to tampering. Because each block references its predecessor, any attempt to alter stored information would change the entire chain and be rejected by the majority of the network, rendering manipulation extremely difficult. This combination of cryptographic security and decentralised consensus confers a high degree of confidence in the immutability and transparency of transactions.

Cryptocurrency trading explained: price speculation and long/short positions

Cryptocurrency trading is the act of speculating on the price movements of digital assets with the aim of obtaining a financial gain.

In its simplest form, this takes place on spot markets, where cryptocurrencies are bought or sold at the current market price and ownership of the underlying asset transfers at settlement.

In addition to spot trading, cryptocurrency markets support a range of derivative instruments, including perpetual futures, dated futures, options, and contracts for difference (CFDs). These instruments allow traders to take long or short exposure without owning the underlying asset and are the primary means by which short selling is implemented in cryptocurrency markets.

If a trader anticipates that the price of an asset will rise, they open a purchase (a long position) intending to close it at a higher price. Conversely, if they expect the price to decline, they may enter a short position, aiming to close once the price has fallen. The ability to short, however, depends on the trading instrument used.

While the conceptual framework of crypto trading is straightforward, its practical execution is considerably more complex. Digital assets exhibit high price volatility, which can create opportunities for profit but also presents a risk of substantial losses in the absence of prudent fund management.

Cryptocurrency trading instruments: Spot vs derivatives

Cryptocurrency trading can be conducted using spot instruments or derivatives, each serving different trading objectives. Spot trading involves buying or selling the underlying cryptocurrency at the current market price, with ownership of the asset transferring to the trader upon settlement. Spot markets are commonly used by participants seeking direct exposure to a digital asset, whether for shorter-term trading or longer-term holding.

Derivatives, such as futures, perpetual contracts, options and contracts for difference (CFDs), allow traders to speculate on price movements without owning the underlying cryptocurrency. These instruments are typically used to gain leveraged exposure, hedge existing positions or take short positions more efficiently than in spot markets.

A key distinction between spot and derivative trading lies in how short positions are implemented. In spot markets, short selling is generally not possible without borrowing the underlying asset through margin facilities. By contrast, CFDs and other derivatives are structured to allow traders to take long or short exposure directly, without owning or borrowing the cryptocurrency itself.

This distinction has implications for custody, fees and risk. Spot traders typically take custody of the asset, whereas CFD traders gain price exposure only.

Derivative trading usually involves leverage, which enables traders to control a larger position with a smaller amount of capital, known as margin. While leverage can enhance potential returns, it also increases risk. If the market moves unfavourably and margin requirements are no longer met, positions may be liquidated automatically, potentially resulting in rapid and substantial losses.

For example, a trader using 5× leverage controls a position five times larger than their initial margin. In such a case, an adverse price movement of approximately 20% may be sufficient to exhaust available margin and trigger automatic liquidation. This mechanism can result in rapid losses, particularly during volatile market conditions or sudden price gaps.

The availability of spot and derivative products, permitted leverage levels and margin requirements vary by jurisdiction and by broker or exchange. Regulatory frameworks may restrict certain instruments or impose leverage caps, meaning not all products are accessible to all traders in every region.

How does cryptocurrency trading work?

Unlike traditional financial markets, cryptocurrency markets operate almost continuously: trading is available 24 hours a day, seven days a week, 365 days a year. This uninterrupted availability increases their appeal to traders irrespective of geographic location.

However, this continuous, decentralised trading structure also affects execution and risk. Crypto trading is fragmented across multiple venues, and liquidity can vary significantly by exchange, trading pair and time of day. During off-peak hours or weekends, thinner order books may result in wider spreads and increased slippage, while the closure of related traditional markets can lead to sharp price adjustments when they reopen.

Cryptocurrency trading occurs on both centralised exchanges (CEXs) and decentralised exchanges (DEXs). Centralised exchanges act as intermediaries, custody user funds, and operate traditional order books, typically offering high liquidity and continuous operational support. Decentralised exchanges, by contrast, rely on smart contracts to facilitate peer-to-peer trading directly from users’ wallets, without a central operator.

The choice of venue has important implications for risk. While CEXs provide convenience and liquidity, they expose traders to counterparty risk, as exchanges may be subject to hacking, insolvency or operational failure. DEXs reduce reliance on intermediaries through self-custody, but often operate with limited regulatory oversight and introduce technical and smart-contract risks.

In practice, cryptocurrency trading begins with a trader selecting both the instrument they wish to trade and the venue on which to trade it. Where a centralised exchange is used, traders must usually create an account and complete identity verification procedures before trading. Once access is granted, funds must be deposited, either by transferring fiat currency via bank transfer or card payment, or by depositing cryptocurrency from an external wallet, depending on the platform and jurisdiction.

With funds available, traders place orders to buy or sell cryptocurrencies. Orders may be executed immediately at the prevailing market price or set to execute only if a specified price level is reached, depending on the order type selected. Given the volatility of cryptocurrency markets, the timing and structure of order placement can materially affect trading outcomes.

After a trade is executed, decisions must be made about custody. To transact in cryptocurrencies, users require a wallet that stores private keys, which are cryptographic credentials necessary to authorise transactions and control ownership of digital assets.

Wallets are commonly categorised as hot or cold. Hot wallets are connected to the internet and permit rapid access to funds, making them convenient for active trading. Cold wallets are typically hardware devices or paper records used to secure larger holdings; they are deliberately kept offline to reduce exposure to cyberattacks.

Finally, open positions and holdings require ongoing monitoring. Cryptocurrency markets are highly volatile, and traders commonly apply risk controls such as position sizing, stop-loss orders and diversification in an effort to manage potential losses.

Order types and trade execution basics

Cryptocurrency trades are executed through an order book, which lists open buy orders (bids) and sell orders (asks) at different price levels. The difference between the highest bid and the lowest ask is known as the bid–ask spread and is a key indicator of market liquidity.

A market order is executed immediately at the best available price and is typically used when speed of execution is prioritised over price certainty. In volatile or thinly traded markets, however, market orders may be filled at less favourable prices due to slippage.

A limit order allows a trader to set a specific price at which they are willing to buy or sell. This provides greater control over execution price and may help reduce trading costs, but execution is not guaranteed if the market does not reach the specified level.

A stop order is triggered once a predetermined price level is reached and is commonly used to limit losses or manage risk. A stop order is triggered when a specified price is reached, at which point it submits a market order for execution; the final execution price depends on available liquidity and may differ from the stop level.

Liquidity conditions affect execution quality. In markets with limited depth, larger orders may be filled across multiple price levels, resulting in partial fills and increased execution costs, particularly during fast-moving market conditions.

Costs and execution in crypto markets: fees, spreads and slippage

Trading cryptocurrencies involves several layers of cost that can materially affect overall performance. Most exchanges apply maker and taker fees, where traders who add liquidity to the order book (makers) typically pay lower fees than those who remove liquidity by executing immediately (takers). In derivative markets, particularly perpetual futures, traders may also incur funding rates, which are periodic payments exchanged between long and short positions to keep contract prices aligned with the underlying spot market.

Additional costs arise from the bid–ask spread, which reflects the difference between the highest buying price and the lowest selling price in the order book. On blockchain-based venues, traders may also face network (gas) fees when transferring assets or interacting with decentralised protocols, with costs varying according to network congestion.

Slippage occurs when an order is executed at a different price from that expected, often because available liquidity is insufficient to fill the entire order at the quoted price. This effect is more pronounced during periods of heightened volatility, around major news events, or when trading less liquid cryptocurrency pairs, where order book depth may be limited.

Traders commonly seek to reduce execution costs by using limit orders rather than market orders, avoiding illiquid trading pairs, and placing trades during periods of peak market liquidity, when spreads are typically narrower and execution more efficient.

Crypto technical analysis: key indicators, chart patterns and volume signals

The principal methodologies of technical analysis are widely applicable to cryptocurrency trading. Because cryptocurrencies are less directly tied to macroeconomic or corporate financial metrics in the same way as foreign exchange or equities, technical analysis often assumes greater prominence, effectively substituting for aspects of traditional fundamental analysis.

Accordingly, commonly used technical analysis techniques in cryptocurrency markets include price action analysis, chart patterns (chartism), and the use of technical indicators (such as the Relative Strength Index, MACD and stochastic oscillators), as well as detailed analysis of trading volume and candlestick formations.

A fundamental approach to cryptocurrencies

Although conventional fundamental metrics (such as price-to-earnings ratios) are not generally applicable to cryptocurrencies, it is possible to adopt a project-level fundamental approach. This involves assessing the viability of a crypto project by examining its whitepaper, the credentials and track record of the development team, the token economics (tokenomics) and the token’s utility.

Such project analysis is particularly important for nascent tokens, since inadequate due diligence may expose an investor to projects vulnerable to manipulation, security breaches or fraud.

Key risks of cryptocurrency trading: regulation, volatility and market manipulation

Trading cryptocurrencies requires not only familiarity with their technical mechanics but also a robust assessment of the associated risks. While these risks often overlap, they can be grouped into several broad categories that traders should evaluate before engaging in cryptocurrency markets.

Market risk (volatility and price gaps)

Cryptocurrencies are highly volatile and can experience sharp price movements over short periods, sometimes outside expected trading ranges. While volatility may create profit opportunities, it also exposes traders to rapid losses, particularly during periods of market stress or low liquidity. Individual risk tolerance should therefore play a central role in any decision to trade digital assets.

Liquidity risk (spreads and slippage)

Liquidity varies across cryptocurrencies and trading platforms. In less liquid markets, wider bid–ask spreads and slippage can lead to execution at less favourable prices, increasing transaction costs and risk, especially during fast-moving market conditions.

Leverage and liquidation risk

Many cryptocurrency platforms offer leveraged trading, which magnifies both gains and losses. Adverse price movements may result in forced liquidation if margin requirements are no longer met, particularly where position sizing or risk controls are inadequate.

Counterparty and settlement risk

Cryptocurrency trading often depends on intermediaries, especially centralised exchanges. These introduce counterparty risk, as hacking, insolvency or operational failure may affect access to user funds. Settlement risks may also arise from the failure or depegging of stablecoins used in trading.

Operational and security risk

Exchanges and user accounts remain vulnerable to hacking, phishing and other cyber threats. Historical security breaches highlight the importance of operational safeguards such as strong passwords, two-factor authentication and secure key management.

Regulatory and tax risk

Regulatory and tax frameworks for cryptocurrencies vary widely by jurisdiction and may change rapidly. Restrictions on trading activity, exchange access or tax treatment can materially affect market participation and outcomes.

Risk mitigation considerations

Effective risk management combines technical analysis, project due diligence and disciplined use of risk-control tools. Common measures include prudent position sizing, stop-loss orders, careful venue selection and the use of cold storage for long-term holdings.

Risk management essentials for cryptocurrency trading

Effective risk management is central to sustainable cryptocurrency trading, particularly given the volatility and leverage commonly associated with digital asset markets. Traders typically begin by defining position size, ensuring that no single trade exposes an excessive proportion of total capital. Position sizing is closely linked to risk-to-reward planning, where potential losses are assessed relative to anticipated gains before a trade is entered.

Stop-loss and take-profit orders are commonly used to enforce this discipline. A stop-loss is designed to limit downside risk by closing a position once a predefined price level is reached, while a take-profit order locks in gains if the market moves favourably. Together, these tools help remove emotional decision-making during periods of sharp price movement.

Where leveraged products are used, additional controls are required. Leverage amplifies both profits and losses, increasing the risk of rapid drawdowns or forced liquidation. Traders therefore often limit leverage and avoid excessive exposure to highly correlated assets. In cryptocurrency markets, this includes managing correlation risk between Bitcoin and alternative cryptocurrencies, which frequently move in tandem during periods of market stress.

Practical safeguards further support risk control. Diversification across assets and strategies can reduce concentration risk, while maximum daily loss limits help prevent a series of unfavourable trades from escalating into significant capital erosion. Traders may also engage in scenario planning, considering the impact of sudden price gaps or liquidity shocks to ensure positions remain resilient under adverse conditions.

FAQs

What is cryptocurrency trading?

Cryptocurrency trading is the act of speculating on the price movements of digital assets, such as Bitcoin, with the aim of achieving a financial return. Traders may buy an asset if they expect its price to rise (taking a long position) or seek to profit from falling prices by taking a short position, depending on the trading instrument used.

Trading can take place on spot markets, where the underlying asset is owned, or through derivatives that provide price exposure without ownership.

What are the main risks of cryptocurrency trading?

Cryptocurrency trading involves several significant risks.

Regulatory uncertainty remains a key concern, as legal frameworks, restrictions and tax regimes vary by jurisdiction and may change over time.

High market volatility means prices can move sharply over short periods, increasing the potential for rapid losses.

Security risks persist due to exposure to hacking, scams and cyberattacks affecting exchanges and user wallets.

Market manipulation may occur in less regulated environments, where large market participants can influence prices.

How are cryptocurrencies analysed for trading?

Cryptocurrencies are commonly analysed using technical analysis, which plays a prominent role given the absence of conventional corporate or macroeconomic fundamentals. Traders frequently examine price action, chart patterns, technical indicators such as RSI or MACD, trading volume and candlestick formations.

In addition, a project-level fundamental analysis may be applied, assessing factors such as a project’s whitepaper, the development team, token economics and the utility of the token, particularly when evaluating newer or less established cryptocurrencies.