‘Shorts’ and ‘Shorting’, Explained
Admin
Sep 6, 2021
Shorting is a trading method that involves selling an asset – like Bitcoin– with the hope of rebuying it later at a lower price. Traders enter a short position with the anticipation that the asset will decrease in value. Traders often ‘short’ (meaning to ‘short sell’) when they expect the price to drop for a short period or if they are “bearish” on a particular asset. Shorting is mainly done through margin trading.
How does Shorting Work?
In order for a trader to open a short position, they will usually borrow a cryptocurrency and sell it at its current price on a trustworthy exchange like MEX Digital. By selling the crypto, the trader is expecting the crypto’s price to drop in value. The trader will then rebuy the crypto at a later date, once its price has fallen, and repay the capital that they borrowed. The end goal is for the price of the crypto to drop, so that the trader can make a profit on the difference between the cost of selling high, and buying it low.
Let’s look at a practical example:
You believe that the price of Bitcoin is going to fall from its current price of $58,000. Therefore, you borrow one BTC from an exchange and sell it at market value. You now have $58,000.
The price of Bitcoin drops to $30,000
You rebuy one Bitcoin for $30,000 and return the capital you borrowed from the exchange plus any interest incurred.
You make a profit on the difference between the cost of buying and selling. ($58,000 - $30,000 = $28,000 (excluding the interest)
The easiest way to short crypto is through margin trading, which allows a trader to borrow capital from a broker (usually an exchange)
Why do Traders Short?
The main benefit of shorting is that it increases the number of trading opportunities in the market. Shorting provides more opportunity for traders as they can profit from both an increase or a decrease in the price of an asset. Hedging is another reason why traders short. Hedging is used by traders as protection against any losses on a long position they are currently in.
How Does Shorting Disadvantage Traders?
With shorting, you only make money if the price goes down. If you are wrong, and the price increases drastically, you will be in trouble as your loss is potentially limitless. Whereas in the case of a long position, the amount you stand to lose is capped, regardless of your position size, you can only lose the capital you initially spent.
Benefits and Risks
The main benefit of shorting is the potential to make a large amount of money shorting a volatile asset like Bitcoin. A prime example is the non-fictional based movie “The Big Short”, where Mark Baum’s team made $1 billion shorting the housing market in 2008 during the housing market collapse.
Although the potential for profit in shorting a volatile market like the crypto market is incredible, there are also extreme risks. For example, if you are in a long position with Bitcoin, its price can only ever drop to zero, meaning that you can only ever lose your initial investment, and nothing more. In a short position, however, the price of Bitcoin has the potential to rise indefinitely, effectively making your losses infinite.
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Remember, proper diligence and sound judgement should be used in evaluating the risks associated with these activities. Trading cryptocurrency carries significant risk and losses can exceed deposits. Refer to our Terms and Conditions and disclosure material.
