Given that the price of cryptocurrencies is very volatile, what do you do when the price of the cryptocurrency you are holding, keeps going down? If you have a relatively small amount, then you might not worry too much about it. You can afford to keep holding until nothing is left. But what if you bought enough for you to care? At which price point do you exit? Once you provide a precise answer to this, you have essentially created a trading plan. How will you approach this problem?
You can, for example, decide to sell if its price goes under the lowest price of the previous year and buy back again if it goes higher than its highest price this year. This would be what I call defensive trading. You are only going to put your investment at risk when you believe the price is going to rise. If you no longer believe the price will rise, then you close your trade to stay out of the market and be in a neutral position.
Instead of just trying to defend the value of your investment from declining price, you may also decide to take advantage of the declining price and short-sell the market if your exchange or broker provides the facility for this. This is what I would call offensive trading because instead of just defending the value of your investment when the price declines, you have plans to increase it.
When deciding whether to buy stocks or shares of a company, people can read a company's financial statement and try to determine the company's share price based on their estimation of value. With cryptocurrencies, there is no such thing. Most people read the news on which to base their trading decisions, believing they can be informed about potential events that might increase or reduce the demand for a particular cryptocurrency.
Others study the movement of price, believing that everything you need to know about whether you should buy or sell something is reflected on its price. It goes up because more people are seeing an opportunity. It goes down when more people are scared. Price is, therefore, a measure of the fear and greed of all participants in a market.
Whatever your method is, you would like to be able to test it right? You can back-test it by seeing how your approach would have performed in the past. If you do not have access to the data you need to do this, then you might be left with the option of paper-trading it. You record the date, the time, how much you bought and the price at which you would have bought or sold if you were to follow your trading plan without actually trading with real money.
Paper trading gives you the advantage of seeing whether your premise and assumptions are correct without the risk of losing money. Based on the trade statistics you collect, you can then calculate how much your investment is worth with you trading it, rather than just holding it.
You may also prefer to trade with a very small account so you only lose cents if your trading method is faulty. Cryptocurrencies have an added advantage over most tradeable assets or commodities of being divisible in small amounts that you can trade a trade size with the equivalent value of a cent or less, if you wish.
Trading with a small account has an added advantage of engaging you mentally and emotionally about your trades so you can practice and get used to them to ensure they do not get in the way in your discipline following your trading method. Your exchange also provides you with reports of your actual trading entries and exits, as well as the costs of commissions and fees which eat lots of your trading profits when you are frequently trading.
After some time, you have the option of actually trading real money. If you have managed to maintain or increase the value of your investment strategy better than just holding it, then perhaps you can consider trading for real. You would also like to weigh whether it was worth you having to get up at odd hours of the night to trade, sacrificing your weekends trading, analysing your numbers.
You need a sufficient number of test trades — naturally, the more test trades you can do, the better. I would suggest you have a thousand, but for most, that is unrealistic unless you find great fun in compiling and analysing data. In reality, most people want to get started after just a few wins. Given this reality then, the rule of thumb is: the shorter your trading timeframe, the more test trades you need. If your trading tries to take advantage of price movements in a day, then I would at least trade 100 times or more to get a good idea of how it fares. If you want to focus on catching the bigger price movements in a year, instead of the small intra-day price movements, then I would look at having around fifteen to thirty.
How are you testing your trades? Please share with us what works for you when it comes to paper trading or what you do before you decide to trade any asset or a commodity.