Trading bitcoin: crypto exchanges & common order types
Bitcoin has democratised trading and brought millions of new users to cryptocurrency exchanges, but it can be intimidating. To help you get up and running, here's a guide to the most common order types.
The price of bitcoin you see reported is mostly an amalgamation of many cryptocurrency exchanges price. There’s no one set price because each exchange has its own volume and trading patterns. In this article, you’ll learn the basics of trading and some of the more advanced terms and techniques to help you trade bitcoin more efficiently.
If you’re still looking to dip your toe into the world of cryptocurrency, take a look at the other introductory guides on the Cloudbet blog. Otherwise, read on to get an understanding of how to trade bitcoin on an exchange.
The fact of trading today is that it’s mostly done by bots. These computer programs are able to execute thousands of highly complex trades per second. However these programs aren’t perfect, there are many documented cases of “flash crashes”.
This happens when markets drop triggering sell orders in these bots. As more sell, the price drops even more, triggering stop orders and meaning even more gets sold, reinforcing the cycle until someone pulls the reins to stop the mass sell off. When this happens, the market usually recovers very quickly - hence the term, flash crash.
An exchange is nothing more than a platform where buyers and sellers meet to conduct trades under a fixed set of rules enforced by a trusted third party - the exchange operator. By having an intermediary mediate exchanges, parties are able to trade even while not knowing or trusting each other, so long as they trust the middleman. The exchange operator usually enforces rules algorithmically, while also arbitrating any conflicts that may arise.
Types of trading
Most crypto evangelists will speak of the markets increasing in value. Indeed when most people buy crypto, they’re also hoping for an increase in value of their coins. This is what’s known as long trading, you’re betting on something you buy to one day be more expensive. You can then sell for a profit.
But don’t worry if you’re more of a glass half-empty type, as there’s also room for pessimism. Traders might be confident the market will drop in value, taking a “short” position in the market means you think the price of something will decrease. This requires a different level of understanding and there is much more risk involved, so for this article, we’ll just cover long trading.
How exchanges work
At its core, all trade happens via an order book, where market makers create liquidity by placing orders - either buy or sell - and market takers can then choose the price they deem fair.
As soon as a taker accepts a price set by a maker, the trade is executed and that order is removed from the book, pulling up the next one in line. Orders are arranged by price, and when two orders carry the same price, the earliest one is executed first.
Each order book corresponds to a single trading pair, identified by a ticker (usually comprised of three or four letters, like USD for dollars or BTC for bitcoin). This means that if you want to trade dollars for bitcoin, you’ll head to the BTC/USD order book. If you would like to trade between bitcoin and euro, you need to make sure the exchange offers the BTC/EUR pair.
Using the same example, if you would like to exchange from USD to EUR and the exchange doesn’t offer a USD/EUR book, you can use BTC to bridge from one to other by executing two trades: first you exchange your USD for BTC in orderbook #1, then you use your newly-acquired BTC in order book #2 to exchange it for EUR. Ta-dah! Magic.
Order books have wildly varying liquidity, with some pairs barely trading at all while others carry billions and billions of dollars in orders - so bear that in mind when going for smaller, illiquid currencies. As a consequence, one can use the distribution, value and volume of all orders in a book to gauge a lot of information on the assets being traded. This can help inform market sentiment, supply and demand curves and a myriad other indicators.
Exchanges profit by exacting fees from parties that trade over their platform. Some charge more fees than others, and these vary greatly from one platform to another, so it’s worth checking them out before you choose one. The most common fees are:
- Trading fees: usually a percentage applied over the total value of the trade. Some exchanges charge a bigger rate from market takers (who remove liquidity), others apply the same rates for both parties. A few of them don’t charge fees at all.
- Withdrawal fees: usually a flat fee charged for withdrawing fiat or crypto from your exchange account. Depending on the currency, it can be quite expensive as operators sometimes “forget” to update their fee schedules to account for price changes. Beware.
- Deposit fees: a fee for depositing fiat or crypto into your exchange account. Few places still charge this type of predatory charge. Steer clear.
- Payment processing fees: usually when paying in and out of credit and debit cards, or when using international banking like SWIFT. These can include a minimum flat fee, plus a hefty percentage, which is charged by the payment processor.
Basic order types
Orders are ultimately the automation of thought into a set of fixed instructions that will be executed once certain conditions are met. They are financial algorithms triggered by one or more events, which have parameters set by traders that place them.
Sounds familiar? That’s because it is. This is the same premise behind trading bots, although bots are much more flexible and can operate indefinitely without human input (not that this is a good idea, as we’ve seen at the beginning of the article).
Bots can concatenate more parameters and execute much more complex sets of instructions, but they require expert knowledge. Orders, on the other hand, give human traders at least some power in the bot trading world, as they add a lot of speed to the mix.
Each exchange offers a different set of order types, and each one adds flexibility to the possible trading strategies. Placing orders is like playing a chess game, one builds a strategy by anticipating the next moves according to one’s desired outcomes.
Basic order types are the simplest sets of instructions, and are easy and intuitive to grasp. If trading were a board game, these orders would be like playing checkers. Most, if not all exchanges offer these orders.
We’ve briefly mentioned market orders already. This is the simplest trade to execute, as long as there is sufficient volume to match your order it will be completed instantly. A market order to buy is filled at the ask price (the lowest sell order in the book); a market order to sell is at the bid price (the highest buy order in the book). You can’t place restrictions on market orders.
A limit order to buy sets the highest price a trader is willing to pay for the trade. It will be executed when the price reaches the set level or lower. A limit order to sell sets the lowest price they’re willing to sell for, and will executed once price reaches that level or higher.
Once you’ve placed a limit order, funds are normally reserved in your account and your order appears in the order book. You’re still relying on the market to move in the way you’d like to though.
Placing a limit order doesn’t guarantee your trade will be executed. There are ways of timing limit orders so that you can remove or amend them if they aren’t executed:
- Good ‘Til Cancelled: This places a trade in the order book that remains active indefinitely until it’s fulfilled, hence the name. And you thought trading was complex. GTC orders mean you don’t have to constantly watch the markets in order to execute your trades but you’re at the mercy of volatility.
- Execute by: Similarly you might choose to set an expiry date on a trade. In this case you’ll select your trade to execute by a certain time and date, or the order will be automatically cancelled.
- Fill-or-Kill: a fill-or-kill order isn’t as dangerous as it sounds. This designation of limit order means that the trade must occur immediately or not at all. This is particularly useful in fast-moving markets.
Advanced order types
Some orders can be more complex, adding different parameters and requiring more knowledge from traders. In our board game analogy, these would be like a chess game, with each piece having distinct and more intricate patterns.
Not all exchanges offer all of these, and some may not even offer them at all, so it’s always best to check which orders your choice of platform offers before depositing.
Stop orders are a way of traders protecting their profits or minimise their losses if the price suddenly changes. They’re only executed if the price of reaches a certain level.
They’re different to a limit order because once they’re activated, they turn into a market order. So they might fill at slightly different prices compared to how the market moves. Sometimes, if prices moves fast enough, a stop order can be completely skipped, so be careful and don’t rely solely on this if you suspect a big level of volatility.
Say you want to place an order without influencing the market. You might want to place a large order of a crypto without much volume for instance. In this case you’d place a hidden order. These aren’t displayed in the order book and are executed after the “visible” orders.
For exchanges that differentiate fees for maker and taker, hidden orders usually pay as market takers, even if they are technically making.
The post-only limit order option ensures your limit order will be added to the order book and not match with a pre-existing order. If your order would cause a match with a pre-existing order, your post-only limit order will be canceled or not execute immediately.
If your exchange charges different fees for being a market maker or market taker, a post-only limit would ensure you pay the maker fee (normally lower than the taker fee).
If you want to mitigate risk, then you may choose a One Cancels Other order, which as the name suggests, means that two orders are placed at the same time. As soon as one is fulfilled, the other is cancelled.
If One-Cancels-Other orders are used to enter the market, it’s a good idea to also place a stop loss order manually to protect against any dips in the price.
Orders for high-volume traders
Now say you’ve got your eye on a substantial amount of crypto at a particular price on an exchange. If you were to place large market orders or even large limit orders, you reveal your position and the market will react. That is why this is almost exclusively used by whales.
There are a few strategies to disguise your position and trade without your actions causing the market to change adversely. This type of order is the rarest amongst exchanges, as they require a very high trading volume to be effective.
This introduces your high-volume order into the market in smaller chunks with slightly varying values so other traders won’t know the true size of your order. The average price of all chunks is the target price set at the moment you create the order.
Similar to a scaled order, this places the bulk of the buy or sell order on the second layer of the order book and fills gradually. Again, this type of ordered is designed to go under the radar of day traders.
Time-Weighted Average Price (TWAP)
This order uses an algorithm to calculate an average price within a time period to figure out a price that you could trade at in order to buy large volumes of a crypto without spooking the market.
This is by no means an exhaustive list, there are countless ways to combine trades. Reading a bitcoin price chart is an art in itself, and can help inform strategies by offering a window into the order book’s execution.
As always, when trading bitcoin on exchanges, as well as with any other aspect of cryptocurrency, always do your own research and only trade with what you can afford to lose. You can learn more about all things crypto on the Bitcoin 101 section of our blog.