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Key Takeaways
- Short selling involves betting on the decline in the price of an asset.
- Understanding leverage, stop-loss orders, funding fees, and margin types (cross vs. isolated) is crucial for successful short selling.
- Shorting crypto with high leverage is not recommended for beginners due to its complexity and high risks.
The Big Short is probably one of the most popular films on the topic of investing. It is a star-studded movie that follows the real story of three groups of people who shorted or betted against the housing market for billions of dollars right before the 2008 real estate crisis. As you might expect, they have ended up making quite a bit of money, but how exactly does shorting work?
What Is Short Selling?
Short selling is a financial maneuver where an investor bets on the price of an asset to go down. Here’s the breakdown:
- The investor borrows shares of the asset from a broker.
- They then sell those borrowed shares on the open market.
- Ideally, the investor repurchases the same number of shares later at a lower price and returns them to the broker. The profit is the difference between the selling price and the repurchase price.
Therefore, it is profiting from a price decline. It is the opposite of traditional investing where you buy an asset hoping its price goes up.
Is Short Selling Crypto Risky?
Yes, shorting crypto is considered a very risky investment strategy if you do not know what you are doing. Here’s why:
- Unlimited Losses – Unlike traditional investing where the most you can lose is your initial investment, losses in shorting crypto are theoretically unlimited. If the price of the cryptocurrency goes up, your losses keep growing.
- Volatility – The crypto market is known for its wild price swings, making it difficult to predict price movements and increasing the risk of getting caught in a short squeeze, where the price spikes unexpectedly and you are forced to buy back at a much higher price to close your short position.
- Magnified gains and losses – Leverage allows you to control a larger position with a smaller amount of your capital. This can be tempting because it offers the potential for magnified profits if the price goes down as expected. However, it works both ways. If the price goes up against your short position, your losses are also magnified by the leverage factor.
- Margin calls and forced liquidation – When you short crypto with leverage, you are borrowing funds from the exchange to place your bet. This borrowed money is called a margin. If the price moves against you and your position falls below a certain threshold (maintenance margin), the exchange will trigger a margin call. This forces you to either deposit more funds (to increase your collateral) or liquidate your position (sell your holdings at market price) to meet the margin requirements.
How Does Leverage Work?
Let’s say Ethereum (ETH) is trading at $3,000 per coin, and you believe the price is due for a correction. You decide to short ETH with 5x leverage, meaning for every $1,000 of your capital, you control a $5,000 short position (5 coins).
- Profit Potential: If your prediction is correct and the price of ETH drops to $2,000, here’s your profit breakdown:
- Profit per coin: $3,000 (selling price) – $2,000 (buyback price) = $1,000 profit
- Total profit (considering leverage): $1,000/coin (profit) * 5 coins (controlled) = $5,000 profit
- Since you only invested $1,000 of your capital, your percentage return is 500% ($5,000 profit / $1,000 capital).
- Loss Potential: However, if the price goes against you and ETH rises to $3,600, here’s your loss breakdown:
- Loss per coin: $3,600 (buyback price) – $3,000 (selling price) = $600 loss
- Total loss (considering leverage): $600/coin (loss) * 5 coins (controlled) = $3,000 loss
- Here, you not only lose your $1,000 capital but also an additional $2,000 due to leverage. This translates to a 200% loss on your initial investment ($3,000 loss / $1,000 capital).
Remember, this is a simplified example. In reality, exchanges have maintenance margin requirements. If the price goes up and your position falls below this threshold, you will get a margin call forcing you to deposit more funds or face liquidation.
Not for beginners: Due to the high risks involved, shorting crypto with high leverage is generally not recommended for beginners. It is best to have a strong understanding of leverage trading, risk management strategies, and the crypto market before attempting this type of trade.
Which Crypto Exchanges Allow Short Selling?
Here are some popular exchanges known for offering shorting cryptocurrencies:
- Bybit: This exchange is known for its user-friendly interface and focus on derivatives trading. Bybit offers margin trading with various leverage options for shorting a wide range of cryptocurrencies.
- BingX: Another popular option, BingX is a Singapore-based exchange that caters to both beginner and experienced traders. They offer margin trading with customizable leverage for shorting various cryptocurrencies.
- KuCoin: This exchange caters to experienced traders and offers margin trading with high leverage for shorting crypto.
Important Note: Before choosing an exchange for shorting crypto, it is crucial to:
- Check regulations in your area. Some countries or regions may restrict shorting crypto altogether.
- Consider your experience level. Shorting with leverage is a complex strategy and carries high risks. It’s best suited for experienced traders who understand margin trading and risk management.
- Compare fees and features. Exchanges have different fees for margin trading and other shorting functionalities. Research and compare before committing.
Short Selling Cryptocurrencies Tutorial
Choose A Crypto Exchange
- Not all crypto exchanges allow shorting. Research reputable crypto trading platforms that offer perpetual futures trading for shorting.
- Shorting crypto is high risk. Before choosing a platform, be clear on your risk tolerance and only consider platforms with robust risk management tools like stop-loss orders.
- Margin Requirements Vary. Each platform has its margin requirements, which is the minimum amount of funds you need to deposit as collateral for the borrowed crypto. Understand these requirements before starting.
Research And Pick Your Cryptocurrency To Short Sell
- Analyze charts through technical analysis, market trends, and news to identify a cryptocurrency you believe will decline in price.
Place Your Short Order
- Leverage: Leverage can amplify gains but also magnify losses. Be cautious and start with small leverage (1x up to 3x).
- Stop-Loss Orders: Set stop-loss orders to limit potential losses if the price goes against you.
- Funding Fees: Be aware of funding fees. In perpetual futures contracts, funding fees are periodic payments exchanged between long and short positions to keep the contract price aligned with the spot price. When shorting, you may need to pay funding fees depending on the market conditions. Factor this into your trading strategy.
- Cross vs. Isolated Margin: This applies specifically to margin trading platforms.
- Cross Margin: When using cross margin, your entire account balance is used as collateral for all your open positions. A drop in any position can lead to a margin call (forced liquidation) if the minimum maintenance margin is not met. This is riskier but allows for potentially larger gains across all positions.
- Isolated Margin: Isolated margin allows you to allocate a specific amount of collateral for each short position. This limits the risk of one position affecting another but also limits potential gains.
Monitor And Close The Trade
- Keep an eye on the market and your position.
- Close the trade by buying back the borrowed crypto at a lower price to lock in your profit.
Final Thoughts
The traditional investment approach involves buying assets and hoping their price appreciates. However, shorting cryptocurrencies offers an alternative strategy for traders who believe the market is headed for a downturn.
Shorting is an advanced trading strategy, but there is a high probability of losing money, even for veteran traders. Always consider alternative strategies that align with your risk tolerance before entering the crypto markets.
Via: 2Usethebitcoin.com
