How to Short Crypto: Profit During Crashes and Retracements
Volatility is an intrinsic characteristic of the cryptocurrency market. A currency that’s on a hike today might experience a dip tomorrow that you couldn’t have imagined. In fact, many coins’ rates constantly change throughout the day. Crypto volatility coupled with regulatory actions can lead to fear-driven flash crashes and slight retracements after big rallies. To avoid experiencing loss when this happens, you can leverage a concept called short selling that allows you to make money when prices are falling — even without owning crypto. In this article, we’ll explain crypto shorting and its associated risks.
What Does Shorting Crypto Mean?
Shorting crypto is the process of selling cryptocurrency at a higher price, with the aim of repurchasing it at a lower price later on, ideally in situations where a crypto asset’s price is expected to fall.
The reason it’s called short selling is that you’re “short” of the coins. You don’t actually own the crypto that you intend to profit from. To understand shorting, you need to be familiar with crypto long and short positions. When you go long, it basically means that you’re buying cryptocurrency, expecting its market value to go higher. For instance, you buy an altcoin at $10 and expect its price to hit $12. You sell it once the price increases in order to make a profit.
On the other hand, shorting means you borrow a cryptocurrency and sell it at the current market price, expecting it to fall. Then, you buy the coin when its price falls or retraces slightly, making a profit which is the difference between your selling and buying prices.
Here’s an example:
- You intend to short one Bitcoin when its value is $45,000 since you expect its price to fall in the next few days.
- You borrow a Bitcoin from a broker and sell it for $45,000.
- A few days after you borrow the Bitcoin, BTC’s price falls to $40,000.
- You buy a Bitcoin for $40,000 and return it to the broker.
- Now you’ve made a profit of $5,000, minus any interest that you have to pay the broker for borrowing the Bitcoin.
Shorting is a way to make money off the decline in an asset’s value. Thus, traders can opt for shorting when they expect a coin’s market value to decrease. Shorting crypto is a risky business, since markets are often unpredictable. Of course, there’s the potential for gains, but with the market’s volatility the likelihood of large losses is equally probable.
When you hold a long position, the currency’s price might drop, but rarely to zero. Even though you don’t make any money, you still have your original investment. When you’re shorting, a coin’s price can rise indefinitely, increasing your losses. That’s why you need to make sure you’ve done your research before you take the leap. If you’re confident about your research and are positive that the price will indeed fall, go ahead and take the calculated risk because it could translate to thousands in profits.
Marketplaces like Bybit and Lendingblock are making it more straightforward for lenders and borrowers to find each other and capitalize on the soaring interest in crypto shorting. With this increasing number of resources, short-selling crypto is becoming more accessible to traders.
Reasons for Short Selling Crypto
Traders have different reasons for short-selling cryptocurrency, depending on how much they want to gain or the kind of analysis they’ve conducted. Following are some reasons for short-selling crypto.
Sometimes, a particular currency might be in a price bubble, or be overvalued at a specific point in time. Traders may pick up on this trend, wanting to short sell their crypto for profit.
Therefore, they short crypto and wait for its retracement to begin. When short selling crypto according to valuation metrics, use a fundamental trading style and analyze the intrinsic value of a coin against its current market price so you’re aware of when you can buy back the borrowed crypto coins.
Crypto’s volatility might be a matter of concern for risk-averse investors, but traders can leverage this characteristic in order to make money. Historically, it’s evident that crypto pricing can rise just as quickly as it can fall.
Traders who have an appetite for risk are naturally drawn to these fluctuations, since they offer potentially large rewards. Thus, traders who are knowledgeable about changing trends and have expertise in the field use the currency’s volatility to their advantage.
While crypto’s volatility might pave the way for short selling, it affects the long position negatively. For instance, if you already have Bitcoin and you believe its price will soon fall, you can decide to short sell the currency.
If your predictions are correct, the profit you get from short-selling crypto can end up reducing or exceeding your long position’s loss. Simply put, having a hedging strategy in place minimizes your losses in a bear market.
What Are the Risks of Short Selling Crypto?
Short selling crypto is definitely a way to make some extra money when the market is down, but you need to consider its risks, too. Below are some notable downsides to shorting cryptocurrency.
When you buy and hold cryptocurrency in the hopes of selling it for a higher price in the future, you’re only exposed to the risk of ending up with a currency that didn’t reach the price you wanted it to.
At the end of the day, you still have your currency, and can continue to hold it for as long as you wish.
On the other hand, your potential losses are limitless with shorting crypto, since they go beyond your initial investment. If the currency price keeps rising, you might have to borrow it at a higher price to lower your average cost if you’re intent on covering without incurring losses.
Bear in mind that when you short sell crypto, you don’t actually own the currency. Instead, you’re borrowing it from a broker, who charges you interest for as long as you hold the coins.
Suppose the currency’s price doesn’t decrease per your predictions. You may have to end up sitting on it for a long time. While this rise is happening, the interest keeps piling up, eating a chunk of your profits.
How to Short Crypto
Before you use any method to short sell crypto, you have to find a trend. Since the market is highly volatile, many factors can send it in either direction. For instance, politics, hype culture and the influence of notable people can disrupt the crypto market.
If you want to know how to short sell Bitcoin, make sure you study its trends, such as sudden interest on the part of a high-end company or billionaire. After that, you have to open your margin trading account. Most crypto brokers have the accommodations for short selling. However, you also have to check your country’s regulations to ensure you’re not challenging any legal guidelines.
Now you know what shorting in crypto is. Let’s discuss how to short the crypto of your choice using different methods.
Direct Short Selling
When learning how to short Bitcoin or any other cryptocurrency, this is the first method most people come across. Simply put, you borrow crypto from an exchange at a specific price and sell it.
Then, you wait for the price to go down. When it does, you buy the currency and return the borrowed coins to the exchange. In this way, you earn the difference between the two prices.
Like all other assets, some cryptocurrencies also have futures markets, in which you agree to buy a security in a contract. The contract specifies the price at which the security will be sold and the time when this will happen.
In buying a futures contract, you bet on the price of a security to rise. Doing this allows you to earn a profit on that security in the future. When you sell the futures contract, it indicates that you expect the price to decline in an upcoming bear market.
If you want to short Bitcoin futures, you can do it on the Chicago Mercantile Exchange, the world’s largest trading platform for derivatives, or with Bybit derivatives.
Contracts for Difference
These are one of the most popular ways to short crypto. With contracts for difference, brokers allow you to bet on a decrease or increase in an asset’s price without having to actually own the asset.
You just have to deposit a part of the margin account’s fund to guarantee that you’ll be able to buy the crypto at the particular price you’re betting on. The deposit remains in your possession, and the exchange or broker only holds it as collateral.
Thus, you only need to supply a certain fraction of the total trade amount to open your position. Because of this, you can amplify your return on investment (ROI) if the crypto moves in the direction you’ve bet on. However, this method obviously carries enormous risks if the currency’s price moves in the opposite direction to that of your prediction.
Crypto Put Options
Can you short crypto without putting your investment at risk? Sort of. If you can deal with complex derivatives in a bear market, you can add buying crypto put options to your list of methods on how to short crypto.
This option gives you the right to purchase a coin at a predefined price on a predetermined date. However, it’s not an obligation. Meanwhile, a put option gives you the right to sell the cryptocurrency.
For instance, if you think that Bitcoin’s price will drop in summer2022, you can buy a Bitcoin put for three months with a price of $30,000. If the price of Bitcoin declines below this strike price on the predetermined date, your put will earn you a trading profit.
On the other hand, if the price remains high, you won’t lose anything except the option premium, which is the fee you paid for holding the option.
If you want to learn how to short crypto while interacting with other investors, then consider prediction markets. These are similar to mainstream conventional markets.
As an investor, you could predict that a specific cryptocurrency will decrease by a particular percentage or margin. Then, someone else has to take you up on that bet. If the price really does go that way, you earn a profit. Some popular prediction markets include Polymarket and Augur.
Tips For How to Short Crypto
Since shorting crypto is based on several factors, you have to ensure you’re taking the right approach. After all, the last thing you’ll want is to short sell crypto during a false retracement. The following are some tips to help you out.
Use Technical Analysis
Technical analysis refers to the use of real-world data to predict how the crypto market will behave in the future, which requires looking at the past performance of the currency you’re interested in, such as its movement and volume.
For instance, if you want to know how to short Bitcoin, you’d look at the trading volume of Bitcoin today in comparison to the past few months.
Technical analysis is based partially on Dow Theory, which asserts that the pricing in a market is dependent on everything from regulations, current demand and past demand to a trader’s knowledge of the coin, their expectations and future demand for the cryptocurrency.
The crux 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.
Moreover, technical analysis is based on the idea that any movement in the crypto market is not merely random, and is based instead on a trend, either short-term or long-term. In most cases, if a currency has followed a trend, it will eventually follow the opposing trend.
Here are some indicators used in technical analysis to help with predicting price crashes and retracements:
- Average directional index (ADX) helps you determine how strong a trend is.
- Bollinger Bands show whether the price of an asset is low or high on a relative basis.
- Standard deviation is applied to the annual rate of return on investment. It shows the historical validity of investments in a cryptocurrency.
- The relative strength index (RSI) indicates momentum in technical analysis. For any recent price change, this indicator determines the magnitude.
With these indicators, you can use trends to determine the opportunity for profits with an investment. 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 (MAs).
When you’re learning how to short Bitcoin or any other altcoin, you need to understand moving averages. In simple terms, moving average refers to the price of a cryptocurrency over a certain period. Typically, the moving average depends on the trading price of a coin in the past 20 days. To make your predictions more accurate, you can connect all of your moving averages.
However, all of these are complex statistical concepts that take some learning. If you’re a novice who’s still learning how to short Bitcoin and other currencies, you may be hesitant to get into complex economics. Keep in mind that factoring in these indicators will allow you to make smarter investments.
Keep Up to Date with the News
Yes, we said “the news” — and not just the crypto news, since politico-economic events can send a market in any direction. Government crackdowns and regulations can lead to flash crashes in the crypto market.
If you suspect something like this is about to happen, you can capitalize on the situation by shorting crypto in the bear market. However, make sure you’re not going against any government guidelines in the process since that could land you in significant trouble.
Short Crypto During Rallies
Can you short crypto during sudden rallies? Yes. This is one of the best times to short any coin. During these rallies, the assets are overbought due to the fear of missing out (FOMO). After the hype dies down, the coin comes back to its original value or declines, providing you with a chance to make profits.
Use Fundamental Analysis
Some experts might not believe cryptocurrency possesses any “fundamentals” at all, since its markets have such a short history. However, you can still use fundamental analysis (FA) to increase your chances of making the right investment decisions.
When doing so, uncover the forces that drive the supply and demand of the cryptocurrency you’re interested in. Some examples of relevant variables include market sentiment, news, trading, adoption and transaction activity.
With fundamental analysis, you study the intrinsic value of a currency. You look at both external and internal factors to determine if an asset is undervalued or overvalued. Since cryptocurrency’s fundamental analysis isn’t the same as that of traditional markets, three different metrics are commonly used.
You can observe these metrics by looking at the data on a blockchain. In fact, you don’t have to do very much, since different websites have already generated this data. For instance, you can see data charts for different cryptocurrencies when spot trading on Bybit.
Transaction count also gives you a fair idea of the activity that takes place on a network. You can use moving averages and even plot a specific time period to determine how the activity surrounding an asset changes over time.
However, use this metric with caution. There’s no guarantee, for instance, whether a high transaction count is due to unique active addresses or the same people transferring funds between their different wallets.
Transaction value tells you the number of transactions completed in a certain period. For instance, if ten people transfer Bitcoin in one day, the transaction count would be ten. If each Bitcoin were worth $40,000, the total transaction value for the day would be $400,000.
Where to Short Sell Crypto
Now that you know what shorting crypto is about, it’s time to learn where to short sell crypto. Ideally, look for crypto exchanges that offer high trading volume for maximum liquidity. Some crypto exchanges that allow shorting include:
Start by making a margin account and logging in to it. Search for the BTC/USD trading pair interface and choose between isolated margin or cross margin. Then, click on “transfer” to send your collateral to the exchange.
After that, start automatic borrowing and set up an auto-repay order. If the price drops, the amount you borrowed from the exchange will be repaid automatically. However, if it goes in the opposite direction, you need to repay the amount manually.
Can you short crypto after reading this guide? Well, you should be able to at least get started. In a nutshell, shorting crypto means selling it at a higher price because you expect its price to decline due to fear in the market or retrace after a price rally. This lets you buy it back later at a lower price. Hopefully, with our handy guide, you now know what shorting crypto is all about, and where to do it legally.