How to Short Bitcoin (BTC)? Steps, Benefits & Risks Explained
Key Questions Answered
Shorting Bitcoin, or any other crypto/stock is an alternative trading strategy that seeks to make profits from a decline in the price of an asset. It involves borrowing the asset and selling it, with the expectation that its value will drop before you have to buy it back and return it to the lender.
The difference between what you sold it for and what you bought it back for is your profit.
Longing an asset, on the other hand, is the conventional process of buying an asset and holding onto it in the hope that its value will increase–basically, “buy low, sell high.”
The same concept applies in shorting, except that the sequence is flipped–”sell high, buy low.”
But how do you sell something without having it in the first place? You borrow it–through something called perpetual contract trade, as opposed to the usual spot trade for long trades.
How to short Bitcoin
There are two aspects to the question, “How to short Bitcoin?” the first being the practical i.e. the platform/tool to use and actions to take, the second being the approach to take to short Bitcoin.
To answer the first, you need to have a margin account, or a contract trading account, with a crypto exchange like Phemex via which you can purchase a perpetual contract and place a sell/short order.
A perpetual contract is a type of derivative product that allows traders to speculate on the future price of an asset without having to actually own it. Perpetual contracts are leveraged, meaning you can trade with more money than what you have in your account and enjoy high levels of liquidity.
For a step-by-step guide, read How do I place a Perpetual Contract Order? – Phemex or watch How to Trade Perpetual Contracts on Phemex.
In terms of the approach, that’s a far tricker question which we will answer in the section below.
When is shorting Bitcoin a good idea?
Short-selling is not a conventional strategy for many investors–investors invest mainly because they expect an asset to appreciate in value. Buying and holding Bitcoin is therefore the safer option.
However, there are times when shorting Bitcoin–or another crypto/stock–can be a viable option:
- When you believe that its value is likely to decrease in the near, short-term future due to pessimistic macro economic factors
- Token-specific event such as a hack or outage
- When technical indicators predict a bearish trend on a narrow time frame that help traders pinpoint the specific moment to set up short positions, such as:
- Relative Strength Index (RSI)
- Bollinger Bands
- Moving Averages
- Average Directional Index (ADX)
Before taking this strategy, however, it is important to understand the risks involved and have a plan in place for covering your position if the stock price increases unexpectedly.
Most importantly, shorting stocks requires extreme finesse with technical analysis and astute assessment of market conditions. Otherwise, losses can easily outweigh any potential gains.
As such, only advanced investors who have a high tolerance for risk and understand the risks associated with short selling should attempt it.
What is the benefit of shorting Bitcoin?
The biggest benefit of short-selling Bitcoin is that you stand to earn outsized profits compared to the amount of money you invest. Given that most short-selling involves leverage, traders can open positions with a fraction of the amount needed for a full position, greatly increasing their buying power. This can result in much larger profits.
All this sounds great, so what’s the catch?
#1 risk in shorting Bitcoin
By far the biggest danger in shorting Bitcoin is the potential for unlimited losses. Unlike a long position, there is no limit to how much an investor can lose when shorting a stock.
Let’s say you buy 1 BTC at the current price of $16,000, your maximum potential loss is just your initial investment of $16,000 if Bitcoin goes to zero. If you short it and Bitcoin goes to $100,000, you have to buy it back at that price.
This makes it essential to use stop-loss orders to limit your downside risk. A stop-loss order is an order that automatically sells your position at a predetermined price, helping you to minimize losses if the market moves against you.
How to set a stop-loss on a short position
Stop-loss orders are used to limit loss or lock in profit on existing positions. They can protect investors with either long or short positions.
A stop-loss order is an instruction to close out a trade at a price worse than the current market level and limit an investor’s loss on a position in a security. When used in conjunction with short selling, it can help to protect traders from unlimited losses if the price of the underlying asset rises sharply.
By setting the stop-loss order at a price below the current market level, traders can limit their maximum loss and ensure that their positions are closed out if the price moves too far against them. This provides investors with more control over their downside risk.
(Note: A stop-loss order is different from a stop-limit order, the latter of which must execute at a specific price rather than at the market.)
How do you protect a gain on a short position?
It is possible to hedge a short stock position by buying a call option. Hedging a short position with options limits losses. However, do note that this strategy has some drawbacks, including losses due to time decay.
(Time decay risk, a.k.a Theta Risk is the risk that a call option’s time value will decrease over time and become worthless. This happens when an option’s expiration date approaches, since it loses its ability to be sold in the market. As such, holding onto a long call option in an attempt to gain profit from an asset’s price appreciation, as well as holding onto a short call option in an attempt to limit losses, become increasingly difficult once the option is near expiration. Time decay risk can be mitigated by closing out the position before the expiration date or rolling the option further out in time for a higher premium.)
What is a Bitcoin short squeeze and what you need to know
A Bitcoin short squeeze occurs when a large number of investors who are shorting Bitcoin are forced to buy back their positions at higher prices. This can be caused by a sudden surge in demand for Bitcoin, leading to an increase in its price and causing investors who shorted the cryptocurrency to suffer losses.
A short squeeze can lead to significant volatility in the price of Bitcoin, because as short traders buy back their positions, this buying pressure causes prices to rise even higher.
Again, this is why stop-loss orders are important.
Other critical risks in short-selling
Dividend risk is the risk that a company will pay dividends while an investor is short selling its shares. This can be particularly problematic for traders who have established short positions in companies that regularly pay dividends. If a dividend is paid out, then it will reduce the price of the stock and increase losses to the trader.
For this reason, it is important to check the dividend policy of a company before taking a short position. Additionally, traders should consider closing out their positions before the ex-dividend date in order to limit any potential losses caused by dividends.
Because contract trading involves leverage i.e. borrowing money, this can magnify potential profits, but also carries the risk of liquidation.
Liquidation can cause a trader to lose all his account balance, if the market moves against him and he cannot fulfill the maintenance obligations i.e. put in more money into his account.
To offset this risk, some traders employ what is called a hedge mode–a trading strategy that involves taking both long and short positions in the same asset or market at the same time. This helps to reduce risk by offsetting any losses from one position with gains from the other, allowing investors to minimize their losses and maximize their profits even if markets are volatile.
In summary, shorting Bitcoin is an effective way to profit from downward price movements in the cryptocurrency market. At the same time, it requires careful risk management. By understanding the basics of short selling and using stop-loss orders, you can maximize your chances of success in this volatile market. With the right approach, you can make significant profits even when prices fall.