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Shorting – what is it
Shorting – what is it
Cryptocurrency
07.09.2021
Updated 18.02.2022
13:47

Many novice traders wonder: ‘How is it possible to get profits during the market fall?’.

When it comes to the rise, everything seems easy: you analyze the market trends, invest in the right assets, and fix the profits. It’s clear, simple, and transparent. But what should a trader do if ‘bears’ are prevailing on the market? The right answer is to open short positions, i.e. short.

In this material, you will find out what shorting is, how to use it, and whether this strategy may be applied to the cryptocurrency market.

What is shorting?

The easiest way to explain its principle is to draw on a securities market. There are ‘bulls’ – those who buy assets in the hope they will go up. It is a long position. And there are ‘bears’ who sell them immediately instead (or borrow with the obligation to pay a bit later) to start selling short. That is a short position. If you analyzed the market correctly, you wouldn’t lose money when the price of assets drops but will be able to earn well or save your capital.

Shorting is used on all markets: we’ve already said about stocks, but it’s also available on the stock market, Forex, and, surely, cryptocurrency exchanges. Both large hedge funds and regular investors utilize the method. And if after opening a long position you usually need a lot of time to get profit, short works vice versa – it will instantly show whether the prediction to short was correct or not.

How to open a short position?

Like we’ve briefly told you above, there are different ways to realize the short. The easiest one is when you sell your asset at one price (for example, 1000 dollars) to further buy it back at another price (for example, $800). That is a short position based on the assets you possess. But more often shorting is associated with borrowed funds – that is why it is so important to understand the principles of margin, futures, and other derivatives.

How can you go shorting if you don’t have the appropriate asset? Let’s consider the example of a cryptocurrency. Let us assume that Ethereum costs 2000 dollars, and you’re sure that the price will go down soon, i.e. you act as a ‘bear’’. After that, you purchase the asset from a counteragent ‘in debt’, immediately selling it on the market. You guarantee to return your partner the money within, for instance, 48 hours at a market price. Now, if the price falls to 1700 dollars, you will be able to pay out the debt at a market price, at the same time earning 300 dollars (surely, without the exchange commission fees). If you were wrong and the price of Ethereum rose to 2400, well, your net loss would be 400 dollars.

How beneficial a short may be?

Like it goes from the example, shorting is quite a risky thing. Because in case your long position didn’t work, you may simply keep the asset waiting for a good moment to leave with minimal losses or even profits. While the short has got its expiration date, after which it may cause significant losses. Many experienced traders get into a ‘trap of short’ losing all their money after one unsuccessful position.

In other words, if you have an asset of 1000 dollars in a long position, the maximum loss you may have is 1000 dollars as the price usually doesn’t go into the red. Talking about an unsuccessful short position, you may lose assets that exceed the initial ‘bet’ two or three times.
That’s why it’s essential to take precautions by having thought about what maximum losses you can afford for this specific short. Surely, you shouldn’t close the position due to the growth of an asset by 1 dollar but keeping the short that failed forever is also a bad idea. Always try to set the stop-loss price upon reaching which the position will be closed automatically.

What exchanges allow shorting?

Because of the fact shorting is an extremely popular tool, the functionality to short is present at almost any trade platform. When using it with cryptocurrencies, shorts receive even higher ‘sharpness’ since the volatility of the market is immense; and the same bitcoin may change its price +/- 20% due to various scenarios within 24 hours.

Technically, it’s pretty simple to open a short at any resource: for instance, on Binance, this may be done in a few steps, which makes it easy even for a novice. Moreover, these days the majority of platforms offer a possibility to open/close positions even from a smartphone without the need to spend hours in front of a monitor. The main thing here is that you must thoroughly analyze and study the market before you open a short. Technical or fundamental analysis may be applied, but you need to evaluate the risks of a short position before you open the short.

Is it worth using shorting?

There is no unambiguous answer to this question. On one hand, this is a highly effective tool that allows you to quickly get profit even in situations where others lose it. It would be a mistake to exclude this tool from your trader’s arsenal. On the other hand, a novice with no experience may easily lose his assets during one unsuccessful short. Short positions bring good income, and the main thing is to use them smartly, taking into account all the risks.