Day Trading Cryptocurrency Strategy (Backtest)

Last Updated on December 4, 2022

Day trading in the cryptocurrency market can offer a lot of profit potential. However, before deciding to day trade cryptocurrencies, you ought to have developed a workable day trading strategy that will help you make consistent profits. So, what is a day trading cryptocurrency strategy?

Day trading cryptocurrency strategy is a method of trading cryptocurrencies where trades are opened and closed within the same day — that is, trades are not rolled over to the next day. It aims to exploit the inevitable up-and-down price movements that occur each day in the crypto market while avoiding unnecessary rollover fees where possible.

In this post, you will be exposed to the concept of day trading and how it applies to the crypto market. At the end of the article, we provide you with a day trading strategy backtest.

What is day trading?

Day trading is a trading strategy where trades are open and closed within a trading day — that is, trades are not rolled over to the next day. It aims to exploit the inevitable up-and-down price movements that occur each day in the crypto market while avoiding unnecessary rollover fees where possible. This strategy can offer a lot of profit potential since the intraday volatility in crypto assets is sufficient to give a reasonable amount of profit in a day.

In general, day traders spend a lot of time analyzing the market by using technical trading indicators and pattern recognition to open and close trades. Day traders use different time frames for analyses. For example, one can use the hourly time frame to identify the trend of the day and use the 15-min timeframe to enter and exit trades. However, there is no definite rule — the choice of timeframe is solely dependent on your trading personality and your trading plan (there is no best timeframe as long as you make money).

Day trading is considered risky and may not be suitable for beginners due to the volatile nature of the market. However, this is not to say that you can’t day trade. If you are ready to put in the work and sacrifice then you may be on your way to profitability, as day trading might offer more trading opportunities than longer-term trading (if you are successful).

To understand how day trading offers more trading opportunities, study these two charts of Bitcoin in different timeframes.

Day trading cryptocurrencies strategy (timeframes)
Day trading cryptocurrencies strategy (timeframes)

Looking at the daily chart above, we can come to two conclusions: First, there was a smooth rally from mid-2020 until somewhere around July 2021. As a buy-and-hold investor, that must have been some sweet profits.

But a look at the situation from mid-2021 to date, we see a different situation. If you had invested in Bitcoin earlier this year, you must be biting your pillow by now. Bitcoin has been in a downtrend since the beginning of the year.

Now, take a look at the 15-minute chart below:

Day trading cryptocurrencies strategy (example)
Day trading cryptocurrencies strategy (example)

Even though only a limited period is shown on the chart, we can see so many price swings, which present lots of trading opportunities. If you were to trade Bitcoin based on the daily bar, you will have a limited number of trading opportunities compared to what you get from an intraday timeframe.

If you are a trader who loves to get every ounce of profits from the market, then trading intraday price fluctuations is your best friend. Although we are not discrediting medium-term and long-term traders, we are simply pointing out the opportunities that can be found in day trading. It’s only a starting point, you have a lot of work ahead of you if you want to make and backtest strategies based on short-term movements. What seems easy on paper, is not so easy in real life. Everything is easy in hindsight!

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Admittedly, the daily timeframe produces a bigger profit size per trade than intraday timeframes. However, with a greater number of trades in the intraday timeframe, you have more compounding opportunities, which makes the overall profits from intraday trading much bigger than what can be gotten trading off the daily timeframe. Moreover, intraday traders can use tighter stops, which allows them to use bigger leverage to increase their profit potential. Thus, for any given win rate and reward/risk ratio, the higher volume of trades offered by intraday trading makes it more lucrative than longer-term trading.

Another benefit is that day trading crypto might offer gains that are uncorrelated to the overall direction of the market. For example, when we were day trading stocks, we had our best year in 2008 when the stock market crashed. We made the most money on long trades despite the market dropping 50%! Please check out our article on bear market statistics:

On the flip side, day trading is time-consuming. Since the volume of trades is more than a swing and position trader, day traders spend most of their time on screen. Even with trading algos, day trading requires more monitoring than position or swing trading. So, before you choose this path, you must learn the psychology of day trading.

Which timeframe is best for day trading cryptocurrency?

This is a subject of debate in the day trading community. In other not to pass a verdict, we will look at some important points on the matter of timeframe.

Frequency of trades

When you are trading a lower timeframe like the 5-min and 30-min timeframe, the number of trades you open will vary significantly, provided you do not open more than one trade per bar on any asset.

Some traders might be inclined to be in and out of trades frequently while others simply would settle for less frequent intraday trades. This might not sound like much until we consider the next point.

Transaction fees

The more trades you make, the more you pay transaction fees. If you are to open and close 20 trades in under an hour, then you will be paying more to your broker in trading fees. If the profits per trade are not big enough to more than cover the trading fees, you are literarily shooting yourself at the foot trading that timeframe.

Also, note that spreads vary across different brokers and exchanges and may eat into your trades if you get on the wrong side of the market.

Risk to Reward

Trading a lower timeframe might force you to have a very poor reward/risk ratio. It is common to see traders trading the 5-min timeframes with tight profit targets and loose stops. The problem with this kind of risk management is that when the market triggers the stop, one loss may wipe out the gains from more than 10 or 20 profitable trades. As a general rule stops usually make a strategy fare worse. You might want to read our take on the pros and cons of using stops:

Moreover, support and resistance levels are not as efficient in a lower timeframe as they are in a higher timeframe like the hourly timeframes.

A good rule of thumb here is to incorporate multiple timeframe analyses. For example, using a 15-min timeframe together with the hourly and daily timeframes. That is, you use the daily timeframe to understand the price structure and identify key levels; use the hourly timeframe to find the trend for the day and look for trading opportunities at key levels; and finally use the 15-minute timeframe to fine-tune your trade entries and exits.

Which crypto is best for day trading?

There are over a thousand crypto tokens available to day traders. However, the list can overwhelm you when deciding on what to trade. In our opinion, large and mid-cap coins tend to be more stable than small-cap coins. And these small-cap coins suffer a lot of intraday price swings which may not be ideal for day trading. Bitcoin, Ethereum, BNB, ADA, ETC, and XRP are quite stable for day trading.

The reason behind choosing an asset with a stable price is to avoid triggering your stops too often (if you choose to use stops at all – there is always a trade-off).

Also, the crypto market is unregulated and is prone to market manipulation, such as pump and dump schemes, wash trading, and several other forms of illegal market participation. Trading smaller coins may expose you to some of these manipulations.

Day trading cryptocurrencies strategy
Day trading cryptocurrencies strategy. 30-min chart of Bitcoin.
Day trading cryptocurrencies strategy
Day trading cryptocurrencies strategy. 30-min chart of LINA.

From the charts above, you can see that price action was a bit less volatile in Bitcoin (the first chart) compared to LINA (the second chart). You can see the spikes of some of the bars; trading in such a market will subject you to using wide stops which might not look good from a risk-to-reward standpoint.

Which is the best indicator for crypto day trading?

The best indicators are the ones you have back-tested to confirm that they work for your strategy. Having said that, the most common indicators in day trading cryptos are trend-following indicators and oscillators. Let’s take a look at some of them.

Moving Averages (MA)

Moving averages are one of the most popular technical indicators in the market. It is a trend-following indicator. This indicator can be used in several ways.

Day trading cryptocurrencies strategy (moving average)
Day trading cryptocurrencies strategy (moving average). 20-period MA on the 15-min chart of Bitcoin.

One of the basic strategies for the moving average is to buy when the price is above the indicator line and sell when the price is below it. As you can see on the above chart, when the price is rising, it is always above the indicator. In the same fashion, downward momentum is seen whenever the price falls below the indicator and keeps moving down. Note that this is a trend-following indicator and, as such, may not work well in a ranging market.

Bollinger Bands (BB)

Just like the MA, the Bollinger band strategy is quite useful to follow the trend while also measuring the volatility of an asset.

Day trading cryptocurrencies strategy (Bollinger Bands).
Day trading cryptocurrencies strategy (Bollinger Bands). 20-period Bollinger Bands applied to 30-min chart of Bitcoin.

Buy signals are generated whenever prices ascend after breaking below the lower band. The opposite is true of a sell trade.

Relative Strength Index (RSI)

The RSI strategy is a popular momentum oscillator used by traders to measure extremes in the market.

Day trading cryptocurrencies strategy (RSI indicator)
Day trading cryptocurrencies strategy (RSI indicator). 20-period RSI on 15-min chart of Bitcoin.

The basic rule of trading the RSI is to buy whenever prices are oversold (below 30) and sell when it is overbought (above 70). But the optimal values depend on the time frame and the asset you are trading. Only a backtest can indicate what are the best levels!

FAQ – day trading cryptocurrencies

Based on the number of e-mails we get we decided to make a FAQ to better address any issues about how to day trade cryptocurrencies:

Is crypto good for day trading?

Potentially, yes, because it has both volatility and some coins have the volume to trade size. But it’s no easy money, actually quite the opposite (see more below).

Sadly, it’s also a place where scammers operate, as has been seen with the FTX scandal. Especially in illiquid coins, you can be sure there are people trying to scam you.

The articles below are not about cryptos, but they touch upon the same principles:

Can you trade crypto 24 hours (24/7)?

Yes, this is a market that is “decentralized” and trades 24/7 day in and day out. It even trades on public holidays, for example, when you are discussing crypto eating turkey on Thanksgiving. You might even make it or break it while you are in the church on Christmas eve!

Which cryptocurrency is best for day trading?

There are no hard and fast answers, but you want to avoid thinly traded coins/crypto to avoid being scammed (unless you are the scammer!). The best recipe for making money is by making sure you have proper data and start backtesting.

What are the downsides of day trading crypto?

The downside of any day trading strategy is that you are most likely going to lose money. Crypto is a zero-sum game. This applies more to cryptos than to stocks. Why? Because there is no value being made with cryptos. If you buy one crypto today, you still have only one crypto ten years after. The same principle applies to gold (gold still has a history of thousands of years of being a sought-after “store of value”).

Opposite, if you own stocks, you own enterprises that create value. A business can grow or shrink, but overall, you take part in the productivity gains (in the stock market as a whole). This is why stocks as a group have performed better than gold over time.

How much can you make day trading crypto?

Most likely you are not going to make any money at all. Unfortunately, you are more likely to lose money. What makes you think you can look at a screen, push some buttons, and then make a lot of money? It requires a ton of work and experience to succeed unless you are a scammer or are lucky.

What is the best crypto day trading strategy?

There is no best or worst strategy as long as you are making money. A dollar (yes, fiat) made in strategy A is just as valuable as a dollar made in strategy B.

How much money do you need to day trade crypto?

The more you have, the better. There are costs involved and the bigger bankroll you have, the less goes to transaction costs, etc.

Which time frame is best for day trading crypto?

You can day trade by using any time frame you want: one hour, 5 mins, or even daily bars. We believe the latter is one of the most underappreciated time frames to use in day trading (see our backtest further below).

Do taxes apply to profits from day trading crypto?

That depends on your residency. Typically, capital gains are taxable and sourced to the country where you reside. We can’t give tax advice. Start by reading the law and then you can have some vague opinion about the potential tax liability. From there, ask a tax advisor. (Also keep in mind that some countries don’t tax capital gains on crypto, but hurry up, that is not going to last long.)

What is the best indicator to day trade cryptos?

None of the indicators should be used in isolation. Indicators work best when you combine a few to create a strategy you can quantify. Make sure you backtest and forward-test your strategy to be sure it is profitable before trading.

We have also published other crypto strategies in our Bitcoin and Crypto Guide. You might also like our article about cryptocurrency trading strategy.

Day trading cryptocurrency strategy (backtest and example)

We have personally yet to dip our toes in the crypto day trading world. We day traded full-time (successfully) for almost two decades, but that was in the stock market which is a rather different market than the crypto market.

Because we have no experience in day trading crypto, we are not going to present any strategy either. Why would we?

Why backtest a crypto day trading strategy?

However, as a rule of thumb, we recommend backtesting ANY strategy that you’d like to trade. If you can’t backtest it, then avoid it and go on.

A backtest with strict trading rules and settings determine if you have a positive expectancy. The backtest gives you statistics and you can make a proper judgment of the historical performance. Does it work? What is the probability of making money with this strategy?

Why is backtesting so important? It’s very simple: if you have no idea how the strategy has performed in the past, how can you figure out if you have a positive expectancy?

Our experience is that most traders don’t have a positive expectancy in the first place, and neither risk management nor “psychology” will ever change this. Without proper backtesting, there is no way of knowing the quality of your strategy. Why would you trade a strategy if you don’t have any information on how it has performed over many trades and years?

How to backtest a crypto day trading strategy

To backtest a day trading strategy is, as a rule of thumb, more difficult and time-consuming than to backtest strategies based on daily bars.

However, you can easily backtest day trading strategies by using daily bars, but it has its limitations. Furthermore, the High and Low price of a daily session is often wrong due to trades being registered from the prior day. We recommend using only Open and Close if you use daily bars.

When you start out backtesting a crypto day trading strategy, we recommend starting with a strategy that is based on daily bars because it’s simply much easier to backtest (and more likely to give you a better result as well). There is a tremendous amount of noise in short-term data, but by using daily bars you limit the “noise”.

To give you an example from the stock market, we can show you a backtest we trade ourselves in Russell 2000:

The day trading strategy below is backtested on the ETF that tracks Russell 2000, IWM, but it can also be traded on the corresponding futures contract @RTY. (The strategy is also included in our online day trading course and thus we don’t want to reveal the strategy in a free article like this).

The equity curve of the strategy looks like this:

Crypto day trading strategy backtest

The day trading strategy is a short strategy that enters at the open and exits at the close.

The 160 trades have an average gain of 0.25% and the win rate is at 63%. In our books, this is a pretty good trading strategy, especially considering it’s a short strategy.

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