The Beginner’s Guide to Crypto Bot Trading Strategies

Crypto trading is about finding a delicate balance between risk and reward, identifying opportunities, and executing trades in a disciplined, precise way. 

A good crypto trading strategy can give structure to your trading, simplifying it, so you can make the most of any opportunity. 

In this article, you’ll learn about the different types of strategies you can apply to crypto bot trading. You’ll come away from the article with a deeper understanding of trading strategies as a concept and the know-how necessary to choose the right strategies for your bots.

What Is a Crypto Trading Bot?

A crypto bot is a piece of software that can make crypto trades autonomously and automatically. It can trade on your behalf based on a pre-defined set of instructions that you give it. Bots are helpful tools because they alleviate the manual work associated with trading, allowing you to focus on building and refining your strategies.

Understanding Trading Strategies

To understand the nuances of crypto bot trading strategies we must first explore the concept of a strategy.

Though it may seem completely obvious at first, defining exactly what a trading strategy is can be pretty difficult.

This is because they’re often confused with other elements of the trading process. Namely, trading plans and trading algorithms.

Trading Plans, Strategies, and Algorithms

Here’s a handy breakdown of the similarities and differences between trading plans, strategies, and algorithms. 

There’s no way to explain what strategies are without the context of a plan. Similarly, it would be difficult to explain what a trading algorithm (used in bot trading) is without first learning about plans and strategies. 

Later on in the article, we will discuss algorithmic trading in more detail.

So, What Is a Trading Strategy?

You can think of a trading strategy like a rulebook, written by you, on which you base your individual trading decisions. A trading plan can’t tell you exactly what to do when the price of Bitcoin suddenly drops by 10%, however, a strategy can — buy or sell — and the algorithm is what will execute the strategy when it’s given to a bot.

Where Does the Trading Strategy Fit Between Planning and Execution?

Simply put, your strategy is what you should be thinking about immediately before making any trading decision. In contrast, a plan is what you should be thinking about before developing any strategy.

Check out our comprehensive crypto day trading introduction article to learn more about these nuanced topics.

Understanding Crypto Bot Trading Strategies?

Now that we have a firm understanding of the scope and purpose of trading strategies we can explore how they apply to automated crypto trading (i.e., trading with bots). 

Crypto Bots vs Human Traders

When trading manually, a human will need to create a plan, then a strategy, and finally execute each trade by looking at market data and carefully referencing the rules defined in the strategy. 

When bots trade they only get to do the last part — execution. They can’t restructure a strategy or change the plan because these things are simply frameworks. These frameworks don’t define individual trading actions clearly enough for a bot to make sense of them.

This is where trading algorithms come into play. 

How Are Crypto Bot Strategies and Algorithms Related?

An algorithm defines the instructions a bot needs in order to make trades, in a language the bot will understand (i.e., in computer code).

The strategy is what the human operator (the trader) will use to create the algorithm (i.e., the trading instructions).

You configure the algorithm as part of your trading strategy and it encompasses the entirety of your strategy’s execution.

Note: No-code crypto trading bots, like the ones provided by Dash 2 Trade, come with a user-friendly interface where you can outline your strategy. The bot will then compile its own set of instructions (i.e., algorithm), based on the input you gave it.

What Is a Crypto Bot Trading Strategy?

A crypto bot trading strategy is the trading framework that the bot operator (i.e., you, the trader) will provide the bot, to serve as the basis for its trading algorithm.

Is There a Difference Between Manual and Automated Trading Strategies?

Manual strategies require a trader’s direct involvement in the execution of trades while automated trading is facilitated by an algorithm.

Most strategies that can be executed manually can also be used with bots but some make better use of a bot’s particular advantages (e.g., speed, consistency, efficiency, and most importantly, discipline).

What Makes a Good Crypto Bot Trading Strategy?

A good bot strategy plays to the bot’s strengths and counteracts the weaknesses of the human trader. 

For example, High-Frequency Trading (HFT) involves making numerous trades over a short period in order to profit from small price changes. A bot can trade like this with ease, while a human will struggle to keep up. 

As simple as this strategy may appear, imagine the price of the traded asset drops massively in the span of a few seconds. A human trader may become excited about the sudden price drop and rush to buy the asset without understanding the market conditions that made it drop so much, so rapidly. Perhaps this asset is only at the beginning of its downward spiral. The trader would have no way of knowing but they may still choose to take on unnecessary risk.  

Crucially, a bot will never make this mistake if configured correctly. 

What Are the Different Types of Crypto Bot Trading Strategies?

There are numerous approaches one could take to trading with bots. 

Most strategies will fall into one of the following categories: 

 

• Trend-based
• Mean reversion
• Momentum
• Arbitrage
• High-Frequency Trading (HFT)
• Scalping
• Swing Trading
• Volume-based
• Sentiment analysis
• Machine Learning/AI

In the table below you can explore what each category is focused on and what makes it unique.  

What Are the Best Crypto Bot Trading Strategies?

Almost any strategy can be configured to be run by a bot instead of manually. This provides an abundance of options to choose from. Ultimately, deciding which strategy to use comes down to your individual needs and goals. 

There is no single best trading strategy for crypto bots but there are some popular, traditional approaches — trend-based trading, momentum trading, and mean reversion. 

Trend-based Strategies

Trend trading is based on the assumption that an asset’s price, if moving in a specific direction (i.e., up or down), will continue to do so in the future. 

Understanding how to identify trends, trend continuations, and trend reversals is crucial in order to use this strategy successfully. 

Tools and Indicators for Trend Trading

Trends can be identified with a few different tools and indicators, which are often used together. These elements will form the backbone of your trend strategy. They can be: 

• Moving Average (MA) indicators
• Momentum indicators
• Patterns and trend lines
• Resistance and support levels

Developing a Trend-Based Crypto Bot Strategy

Armed with a set of indicators you can begin exploring the latest price movements of your crypto of choice, to identify potential trends. Once you’re convinced you’ve spotted sustained upward or downward price movement the next step is to configure your bot to recognize and act on the indicators you’ve been using. 

For instance, you might set your bot to buy a cryptocurrency when its price crosses above a certain moving average and sell when it drops below another. This approach can be fine-tuned by incorporating momentum indicators, like the Relative Strength Index (RSI) or the Moving Average Convergence Divergence (MACD), to confirm the strength and sustainability of the trend.

Additionally, identifying support and resistance levels, chart patterns, and trend lines can provide deeper insights into market sentiment and potential trend reversals or continuations. For example, a breakout above a key resistance level might signal a strong upward trend, prompting a buy action from your bot. Conversely, a breakdown below a support level might indicate a bearish trend, triggering a sell.

What Makes a Trend-Based Strategy Successful?

The key to a successful trend-based strategy lies in its adaptability and responsiveness to market changes. Your bot should be able to quickly adapt to evolving trends and market conditions. Choosing the right indicators and zeroing in on accurate strong signals is a must.

It's crucial to backtest your strategy using historical data to ensure its effectiveness. This process will help you make refinements, adjust parameters, and identify any potential issues that might affect performance.

In practice, a trend-based strategy thrives on continuous optimization. Regularly reviewing and adjusting the strategy in response to new market information can help maintain its edge. This iterative process is what often separates a good strategy from a great one.

Momentum Strategies

Momentum strategies rely on identifying a strong price move before it happens. They’re short-term trading strategies used to cash in on price volatility. The key to successful momentum trading is taking profits right as a price move shows signs of faltering (i.e., losing momentum). 

Trading this way often involves indicators that take into account factors like price and volume (e.g., RSI,  MACD, OBV, MFI) in order to present a picture of the current market momentum. 

Tools and Indicators for Momentum Trading

Traders have a diverse array of tools and indicators at their disposal that they can use to spot shifts in market momentum. They include but are not limited to: 

• Relative Strength Index (RSI)
• Money Flow Index (MFI)
• On-balance Volume (OBV)
• Moving Average Convergence Divergence (MACD)
• Stochastic Oscillator
• Volume Indicator
• Rate of Change (ROC)

Developing a Momentum Crypto Bot Strategy

Building a momentum strategy requires carefully selecting the right indicators for the job and clearly defining signals.

Note: Momentum trading strategies benefit from moderately volatile and highly liquid assets (e.g., BTC and ETH).

Begin by exploring which momentum indicators accurately depict the stronger price moves visible on the charts. Once you’ve identified a few reliable options, think about what the right signals are for entering and exiting the market. 

An example of such a signal would be the RSI crossing a specific threshold, like reversing from an overbought or oversold range (80 and 20 respectively), or the MACD crossing the midway line. These signals will be your BUY or SELL triggers. Include other signals for a more nuanced and specialized strategy. 

Once you have the first draft of your strategy you can start refining it by testing it using a backtester. This is a critical step as it will provide you with detailed insight into where your strategy works and where it fails. Afterward, you can work on ironing out as many issues as you can. 

After backtesting, it’s not a bad idea to test your strategy with a paper trading account (i.e., using virtual currency on a demo account on your exchange of choice). This will put your strategy up against real-time data in a safe environment, possibly shining a light on any overfitting or underfitting that may be happening (we’ll discuss this topic later in the article). 

Finally, it’s time to go live with your strategy. Monitor your bot’s performance closely and make sure to start with a more conservative sum before you’ve seen consistent, positive returns.

What Makes a Momentum Strategy Successful?

Momentum strategies hinge on your ability to get in and out of trades at the right time.

To ensure success, it's important to monitor the market closely and adjust your strategy accordingly. Effective momentum trading also involves a keen understanding of market psychology and the ability to act on significant volume changes that can signal the beginning  and strength of a trend. 

Remember, a well-defined risk management plan is your safety net in this often highly involved and demanding approach. 

Mean Reversion Strategies

The mean reversion trading strategy is predicated on the assumption that prices of crypto assets, which may fluctuate significantly over a given period, tend to eventually gravitate back towards the long-term average (i.e., mean) price. 

Mean reversion strategies make extensive use of moving averages — technical indicators that display the average price of an asset over a given period. 

Tools and Indicators for Mean Reversion Trading

You can include these and other indicators to your mean reversion trading toolbelt:

• Bollinger Bands
• The Relative Strength Index (RSI)
• Moving averages (e.g., SMA, EMA)

Developing a Mean Reversion Crypto Bot Strategy

Begin by choosing the crypto you will be trading, carefully. Generally, this strategy benefits from highly liquid, and stable markets. The stability can make setting the right entry and exit conditions for your bot a lot easier. Taking that into account, mean reversion can also be applied in more volatile conditions, especially when the volatility is around a clear average price level over a certain period.

In crafting a mean reversion strategy for your crypto bot, it's essential to leverage the insights provided by exponential moving averages (EMAs). EMAs are particularly responsive to recent price changes, offering a weighted analysis that prioritizes the latest market activity. Your bot can be programmed to detect when prices deviate significantly from the EMA, signaling a potential reversion opportunity.

To enhance the precision of your strategy, it's wise to integrate an additional indicator, such as the Bollinger Bands. These bands serve as a gauge for market volatility and help in pinpointing the overextended price movements. By setting your entry point when prices fall below the lower Bollinger Band and your exit when they return to the vicinity of the EMA, you create a systematic approach to capitalize on the market's return to equilibrium. This dual-indicator method increases the robustness of your entry and exit signals, leading to more disciplined and potentially profitable trading execution.

As always, don’t forget to rigorously test your strategy, first with a backtester and then out in the real-world markets. Start small, fix as many issues as you can, and only then commit larger sums of money. 

What Makes a Mean Reversion Strategy Successful?

A successful mean reversion strategy requires precise timing to capitalize on the temporary price extremes. It's essential to have a clear understanding of the asset's typical price range and to set stop-loss orders to manage risk. The strategy works best in a market that is neither strongly bullish nor bearish, where prices tend to fluctuate within a predictable range

Common Issues With Crypto Bot Strategies

Bot trading can introduce some unexpected, though easily avoidable, issues that you need to be aware of. 

Underfitting

Underfitting is a common pitfall inexperienced traders encounter when developing their crypto bot trading strategies.

When its strategy doesn’t properly fit the available market data a bot may become slow to recognize and respond to significant market movements, missing out on potential gains and incurring losses. 

This sluggishness can lead to an overall lack of trading activity, as the bot may not identify clear signals to execute trades confidently. 

To combat underfitting, strategies need to be complex enough to discern market patterns accurately but not so complex that they become overfitted to historical data.

Overfitting

Overfitting is the polar opposite of underfitting — when a strategy fits so well to historical market data that it loses flexibility and can’t adapt to real-world market conditions. 

During backtesting continuous tweaking and optimization can significantly improve a strategy but an experienced trader will know when the benefits of optimization start to dwindle and overfitting begins to creep in. 

This is why it’s so important to test your strategies with small sums or with demo accounts in the real world after you backtest and before you fully commit to them.

Forgetting Trading Fees

Trading fees are an inescapable part of trading any asset. The platforms hosting your trading activities need to make money somehow and it’s generally through their fee system. 

Trading fees are often overlooked by newcomers to bot trading but they shouldn’t be. Depending on how you instruct your bot to trade they can stack up quickly, eating into — even entirely devouring — any profits. 

High-frequency Trading (HFT) strategies are especially susceptible to the negative impacts of fees because their per-trade profit is often overshadowed by any fixed fees by the exchange. 

Note: Don’t forget to carefully check the fees set in place by your crypto exchange of choice before you start auto trading.

Explore Dash 2 Trade’s Pre-made Crypto Bot Strategies

If you're keen to explore the variety of strategies and assets available for trading with our crypto bots, head to the backtester page on the Dash 2 Trade app. You'll find a selection of pre-built strategies there.

Take a look at how they're constructed and use the backtester's results page for a clear explanation of their performance, including why they may or may not work. When you’re ready, don’t hesitate to build your own!

Ready to step up your trading game? Join our community on Discord and watch for new features we’re adding to the platform.