- What does it mean to "short a cryptocurrency"?
- Reasons for Short Selling Cryptocurrencies
- Risk hedging
- How to short cryptocurrency
- Direct short sale
- Futures Markets
- Contracts for difference
- Crypto put options
- Prediction Markets
- Tips for Shorting Cryptocurrencies
- Use technical analysis
- follow the news
- Short cryptocurrency during upswings
- Use fundamental analysis
- On-chain metrics
- Number of transactions
- Transaction cost
- Where can I short cryptocurrency?
- Final words
Volatility is an integral characteristic of the cryptocurrency market. A currency that is on the rise today may experience a fall tomorrow that you could not even imagine. Moreover, the rates of many coins are constantly changing throughout the day. The volatility of cryptocurrencies coupled with regulatory action can lead to sudden fear-driven crashes and small retreats after big rallies. To avoid losses in such cases, you can take advantage of the concept of short selling, which allows you to make money during price drops - even without owning cryptocurrency. In this article, we will talk about short selling cryptocurrencies and the risks associated with them.
What does it mean to "short a cryptocurrency"?
Cryptocurrency shorting is the process of selling a cryptocurrency at a higher price in order to buy it back at a lower price, ideally in situations where the price of a crypto asset is expected to fall.
Short sales are called so because you are the "short" owner of the coins. In fact, you do not own the cryptocurrency that you are going to earn. To understand what a short sale is, you need to know what long and short positions in cryptocurrency are. When you go long, it means that you are buying a cryptocurrency with the expectation that its market value will rise. For example, you buy an altcoin at $10 and expect its price to reach $12. You sell it as soon as the price rises to make a profit.
On the other hand, shorting means that you borrow a cryptocurrency and sell it at the current market price, expecting it to fall. You then buy the coin when its price drops or retreats slightly, making a profit equal to the difference between the sell price and the buy price.
Here's an example:
- You are about to short one bitcoin when it is worth $45 because you expect the price to fall in the next few days.
- You take bitcoin from a broker and sell it for $45.
A few days after you took the bitcoin, the price of BTC drops to $40.
- You buy bitcoin for $40 and return it to the broker.
- You have now made a profit of $5 minus the interest you had to pay the broker for borrowing the bitcoin.
Shorting is a way to capitalize on a decrease in the value of an asset. Thus, traders can choose to short when they expect the market value of a coin to decline. Shorting cryptocurrencies is a risky business as the markets are often unpredictable. Of course, there is potential for profit, but given the volatility of the market, the possibility of large losses is no less likely.
When you are long, the price of a currency may fall, but rarely to zero. Even if you don't earn anything, you still have your initial investment. When you take a short position, the price of a coin can rise indefinitely, increasing your losses. That's why you need to make sure you do your research before you jump. If you are confident in your research and you are confident that the price will indeed fall, then take a calculated risk because it could turn into a multi-thousand dollar profit.
Reasons for Short Selling Cryptocurrencies
Traders have different reasons for short selling cryptocurrencies, depending on how much they want to profit or what kind of analysis they have done. Listed below are some of the reasons for short selling cryptocurrencies.
Sometimes a particular currency may be in a price bubble or overvalued at a certain point in time. Traders may pick up on this trend and want to sell cryptocurrencies for a profit.
Therefore, they make a short sale of the cryptocurrency and wait for its rollback to begin. When shorting cryptocurrencies according to valuation indicators, use a fundamental trading style and analyze the intrinsic value of a coin against its current market price to know when you can buy back borrowed cryptocoins.
The volatility of cryptocurrencies can be a concern for risk-averse investors, but traders can use this characteristic to make money. Historically, the prices of cryptocurrencies can rise as fast as they fall.
Risk-averse traders are naturally drawn to these fluctuations as they offer potentially large rewards. Thus, traders who understand changing trends and have experience in this area use the volatility of the currency to their advantage.
While the volatility of cryptocurrencies may open the way for short selling, it has a negative effect on long positions. For example, if you already own bitcoin and you think its price will drop soon, you may decide to short sell the currency.
If your predictions are correct, then the profit you make from shorting cryptocurrencies may eventually outweigh or outweigh your losses on a long position. Simply put, having a hedging strategy will minimize your losses in a bear market.
How to short cryptocurrency
Before any method of short selling cryptocurrencies can be used, a trend must be found. Because the market is highly volatile, many factors can push it in either direction. For example, politics, hype culture, and the influence of famous people can disrupt the cryptocurrency market.
If you want to know how to sell bitcoin short, be sure to study its trends, such as a sudden interest from a high-end company or a billionaire. After that, you need to open an account for margin trading. Most crypto brokers have premises for short selling. However, you also need to check your country's regulations to make sure you're not violating any legal regulations.
Now you know what short selling is in cryptocurrency. Let's talk about how to short sell your chosen cryptocurrency using different methods.
Direct short sale
When you are learning how to short Bitcoin or any other cryptocurrency, this is the first method that most people come across. Simply put, you take a cryptocurrency on an exchange at a certain price and sell it.
Then you wait for the price to drop. When it falls, you buy the currency and return the borrowed coins to the exchange. Thus, you earn the difference between the two prices.
Like all other assets, some cryptocurrencies also have futures markets where you agree to buy a security under a contract. The contract specifies the price at which the security will be sold and the time at which it will be sold.
When you buy a futures contract, you are betting that the price of a security will rise. This allows you to make a profit on that security in the future. When you sell a futures contract, it means that you expect the price to drop in an upcoming bear market.
Contracts for difference
This is one of the most popular ways to trade cryptocurrencies. With CFDs, brokers allow you to bet on whether the price of an asset will go up or down without actually owning the asset.
You just need to deposit some funds into a margin account to ensure that you can buy cryptocurrencies at the specific price you are betting on. The deposit remains at your disposal, and the exchange or broker only holds it as collateral.
Thus, to open a position, you only need to deposit a certain percentage of the total amount of the transaction. Thanks to this, you can increase the return on investment (ROI) if the cryptocurrency moves in the direction you bet on. However, this method certainly carries huge risks if the price of the currency moves in the opposite direction to your forecast.
Crypto put options
Is it possible to short a cryptocurrency without putting your investment at risk? Something like that. If you know how to deal with complex derivatives in a bear market, you can add buying crypto put options to your list of methods for shorting crypto.
This option gives you the right to sell a coin at a predetermined price on a predetermined date. However, this is not an obligation. Meanwhile, a put option gives you the right to sell the cryptocurrency.
For example, if you think that the price of bitcoin will fall in the summer of 2022, you can buy a put option on bitcoin for three months at a price of $30. If the price of bitcoin falls below this strike price on a predetermined date, your put will earn you a trading profit.
On the other hand, if the price stays high, you lose nothing but the option premium, which is the cost of holding the option.
If you want to learn how to short cryptocurrencies by interacting with other investors, take a look at the prediction markets. They are like regular markets.
As an investor, you can predict that a certain cryptocurrency will drop by a certain percentage or margin. Then someone else must accept your bet. If the price does go down, you make a profit. Some popular prediction markets include Polymarket and Augur.
Tips for Shorting Cryptocurrencies
Since shorting cryptocurrencies is based on several factors, you need to make sure you are using the right approach. After all, the last thing you want is to short a cryptocurrency during a false pullback. Below are some tips to help you with this.
Use technical analysis
Technical analysis is the use of real data to predict the behavior of the cryptocurrency market in the future. To do this, you need to study the past performance of the currency you are interested in, such as its movement and volume.
For example, if you want to know how to go short bitcoin, you look at bitcoin trading volume today compared to the last few months.
Technical analysis is partly based on Dow Theory, which states that market pricing depends on everything from regulations, current and past demand, to a trader’s knowledge of a coin, their expectations, and future demand for cryptocurrencies.
The essence of technical analysis is that history will repeat itself in terms of trends and pricing. This information is then used to make predictions about future market sentiment.
In addition, technical analysis is based on the idea that any movement in the cryptocurrency market is not random, but is based on a trend, short-term or long-term. In most cases, if a currency has followed a trend, it will eventually follow the opposite trend.
Here are some indicators used in technical analysis to help predict price crashes and pullbacks:
- The Average Directional Index (ADX) helps determine how strong a trend is.
- Bollinger Bands show if the price of an asset is low or high on a relative basis.
- The standard deviation is applied to the annual rate of return on investment. It shows the historical validity of investing in cryptocurrencies.
- The Relative Strength Index (RSI) indicates momentum in technical analysis. For any recent price change, this indicator determines the magnitude.
With the help of these indicators, you can use trends to determine the possibility of making a profit when investing. You can also use some statistical tools such as Fibonacci ratios and extensions, time-weighted average price (TWAP), volume-weighted average price (VWAP), and moving averages (MA).
When you learn to trade Bitcoin or any other altcoin, you need to understand moving averages. Simply put, a moving average refers to the price of a cryptocurrency over a given period. As a rule, the moving average depends on the trading price of the coin over the past 20 days. To make your predictions more accurate, you can combine all the moving averages.
However, these are all complex statistical concepts that require some learning. If you are a beginner who is still learning how to short bet on bitcoin and other currencies, you may be hesitant to delve into the complex economy. Remember that keeping these numbers in mind will allow you to make smarter investments.
follow the news
Yes, we said “news” – and not only crypto news, as political and economic events can move the market in any direction. Government repression and regulations can lead to sudden collapses in the cryptocurrency market.
If you suspect that something like this is about to happen, you can capitalize on the situation by taking a short position in the cryptocurrency bear market. However, make sure you don't go against any government guidelines as this can get you into serious trouble.
Short cryptocurrency during upswings
Can you short cryptocurrency during sudden rallies? Yes. This is one of the best times to go short any coin. During such rallies, assets are overbought due to fear of missing out (FOMO). After the hype subsides, the coin returns to its original value or declines, giving you the opportunity to make a profit.
Use fundamental analysis
Some experts believe that cryptocurrency does not have any "fundamentals" because its markets have such a short history. However, you can still use fundamental analysis (FA) to increase your chances of making good investment decisions.
At the same time, it is necessary to identify the forces that determine the supply and demand of the cryptocurrency you are interested in. Examples of relevant variables are market sentiment, news, trading, adoption, and transactional activity.
In fundamental analysis, you study the intrinsic value of a currency. You look at external and internal factors to determine if an asset is undervalued or overvalued. Since the fundamental analysis of cryptocurrency is not similar to the fundamental analysis of traditional markets, three different metrics are commonly used.
You can observe these metrics by viewing the data on the blockchain. In fact, you won't have to put in much effort since various websites have already generated this data.
Number of transactions
The number of transactions also gives you an accurate idea of the activity taking place on the network. You can use moving averages and even chart over a period of time to see how the activity around an asset changes over time.
However, use this metric with caution. For example, there is no guarantee that a large number of transactions are due to unique active addresses or that the same people transfer funds between different wallets.
The transaction value shows the accumulated value of funds transferred during a certain period. For example, if ten people transferred bitcoin in one day, the number of transactions would be ten. If each bitcoin was worth $40, the total transaction value per day would be $000.
Where can I short cryptocurrency?
Now that you know what shorting cryptocurrencies is, it's time to find out where you can short sell cryptocurrencies. Ideally, look for cryptocurrency exchanges that offer high trading volume for maximum liquidity. Some cryptocurrency exchanges that allow short selling include:
Can you short cryptocurrencies after reading this guide? Well, you should be able to at least get started. In a nutshell, shorting a cryptocurrency means selling it at a higher price because you expect its price to fall due to fear in the market or to retreat after a price rally. This will allow you to buy it back later at a lower price. We hope that thanks to our handy guide, you now know what short selling of cryptocurrencies is and where it can be done legally.