How to Short Bitcoin: The Art of Profiting from Both Sides
Shorting, or short-selling Bitcoin can be particularly attractive for crypto traders during bear markets or when they anticipate a significant price correction.
(For the uninitiated, short-selling is a trading strategy that involves selling an asset that you do not own, in the hope of buying it back later at a lower price and making a profit. To short-sell an asset, you must borrow it from a broker and sell it on the open market. Once the price of the asset has fallen, you can buy it back and return it to the broker, keeping the difference in price as your profit.)
In this article, we will cover how short-selling works, the crucial questions to ask as well as what you need to pay attention to before placing a short-sell order.
Who is Short-Selling Most Suitable For
Short-term traders, often referred to as day traders or swing traders, aim to profit from short-term price movements in Bitcoin, which can range from minutes to several weeks.
Shorting Bitcoin can be a valuable tool for them because it allows them to profit not only from upward price movements (by buying low and selling high) but also from downward movements (by short-selling high and buying back low). Short-term traders rely on technical analysis, charts, and market sentiment to make quick trading decisions.
They may enter short positions to capitalize on downward trends and market volatility. However, short-term trading can be risky due to the high volatility of cryptocurrencies, so risk management is crucial.
In contrast, long-term traders, often referred to as investors, have a different approach. They believe in the long-term potential and value of Bitcoin, and their primary goal is to hold Bitcoin for an extended period, typically years, or even decades. Long-term investors are less concerned with short-term price fluctuations and are willing to endure market volatility.
However, while long-term traders generally do not short Bitcoin as part of their core strategy, they may use short positions for risk management. For example, if they have a significant long position in Bitcoin and want to protect themselves from potential losses during a bear market, they might enter a short position as a hedge. This allows them to profit from the short-term downside without selling their long-term holdings.
Short-selling is possible because brokers are willing to lend assets to traders for a fee. This is because brokers know that there is a chance that the trader will not be able to buy back the asset at a lower price and will have to make up the difference to the broker.
When To Consider Shorting Bitcoin
Traders typically choose to short-sell Bitcoin under the following conditions:
- They anticipate a bearish market or expect the price of Bitcoin to decline.
- They want to hedge an existing long position in Bitcoin to limit potential losses.
- They want to profit from market volatility by trading both long and short positions.
Questions to Ask Before You Short Bitcoin
Before short-selling Bitcoin, ask yourself these critical questions:
- Why do you believe that the price of Bitcoin is going to fall? Is it just because you heard an influencer say it, or are you well-informed about Bitcoin and the factors influencing its price?
- Do you have a clear exit strategy and risk management plan i.e. do you have a stop-loss order in place to protect yourself from large losses? Do you have enough capital to cover your losses if the price of Bitcoin rises?
- Are you aware of the potential losses, including the possibility of losing more than your initial capital due to margin trading?
- Have you done thorough technical and fundamental analysis to support your short thesis?
Step-by-step Guide to Shorting Bitcoin
So what do you need to do in order to short Bitcoin? Practically speaking, here are the steps:
- Choose a reputable exchange: Make sure to short Bitcoin on a reputable cryptocurrency exchange. This will help to ensure that your funds are safe and that your trades are executed fairly.
- Determine your margin: Shorting Bitcoin with a margin can amplify your profits, but it can also amplify your losses. Be careful not to over-leverage and risk losing more money than you can afford.
- Set stop-loss orders: Stop-loss orders can help to limit your losses if the price of Bitcoin rises. Make sure to place stop-loss orders above your entry price so that you can make a profit if the price of Bitcoin falls.
- Monitor your trades closely: Monitor your short positions closely and be prepared to close them out if the price of Bitcoin starts to rise.
Macroeconomic Analysis
But given Bitcoin’s recent arrival on the world stage as a legitimate asset class, what you really need to do before you embark on a game of shorts is to be grounded in macroeconomics/global financial markets, world events, as well as news about the crypto industry in general.
For example, when Covid struck, Bitcoin fell by almost 50% in a single day.
Other indicators to pay attention to include:
- Inflation rates: High inflation may drive interest in Bitcoin as a store of value (this was why Bitcoin surged to almost $60,000 in 2021, due to the money printing by the US Fed to finance Covid stimulus checks), while low or stable inflation may reduce the urgency to hold cryptocurrencies.
- Interest rates: This is related to the point above; the higher the inflation rate, the more likely there will be interest rate hikes, which is good news for short sellers, as more expensive money means less liquidity available for investment in riskier assets like Bitcoin, leading to price depreciation.
- Geopolitical events: News related to political turmoil or instability can lead to volatility in Bitcoin as well. When Russia had launched a military operation against Ukraine, Bitcoin’s value fell by over 8% over 24 hours.
- Crypto market sentiment: Paying attention to what’s happening in the crypto industry is key for short-sellers. When the Terra Luna implosion happened in May 2022, Bitcoin’s price, which had already taken a beating from the Russian invasion of Ukraine back in February, fell further to $26,000.
Technical Analysis
Besides the above, good short-sellers are also strong in technical analysis. While technical indicators are never fool-proof tools, the ability to accurately identify patterns in Bitcoin’s price and volume charts that can signal a potential decline in price gives a short-seller a strong advantage.
Some common technical indicators that short-sellers use include moving averages, Bollinger Bands, and MACD, as well as Ichimoku Cloud and Volume Analysis.
How A Trader Shorts Bitcoin (An Example)
A trader might see an opportunity to short Bitcoin if they believe that the price is overvalued and is due for a correction. In addition to having a finger on the pulse of the macroeconomic climate and market conditions, they might use technical analysis to identify a resistance level in Bitcoin’s price chart. Once the price of Bitcoin reaches the resistance level, the trader might open a short position.
The trader might use a margin of 5x to amplify their profits. This means that they would borrow 4 Bitcoin from the exchange for every 1 Bitcoin that they have in their account. They would then sell the 5 Bitcoins on the open market.
The trader would place a stop-loss order above their entry price to limit their losses. For example, if they opened the short position at $30,000, they might place a stop-loss order at $31,000.
The trader would then monitor their short position closely. If the price of Bitcoin falls, the trader would make a profit. If the price of Bitcoin rises, the trader’s stop-loss order would be triggered and they would close their short position at a loss.
It is important to note that this is just an example. There are many different ways to short Bitcoin, and the best approach will vary depending on the trader’s individual circumstances and risk tolerance.
In Conclusion
Short-selling Bitcoin offers traders a unique avenue to capitalize on both rising and falling market trends, providing opportunities for profit regardless of market direction. This flexibility is particularly appealing for those seeking to diversify their trading strategies and manage risk in a dynamic cryptocurrency environment.
Yet, it’s essential to approach short-selling with a well-researched plan, a comprehensive understanding of market dynamics, and a commitment to prudent risk management. When executed skillfully, short-selling Bitcoin can be a valuable tool for traders.
