Step 1: Choosing How to Short Bitcoin
There are various ways to short Bitcoin. Let’sexplore two of the most popular methods: through a broker or through derivatives.
Traditional Short Selling
Some Bitcoin exchanges may offer opportunities for short selling, involving borrowing the actual value from your broker or third parties and selling it on the market. If the price indeed drops, you can repurchase the bitcoins at a lower price, return them to the owner, and pocket the price difference.
For instance, if Bitcoin is trading at $40,000 per BTC, but you anticipate a decline, you might decide to borrow one BTC from your broker and sell it on the market. A week later, if the price drops to $32,500, you can repurchase the Bitcoin at the new market price, repay your broker, and keep the price difference, in this case, $7,500 minus broker fees. However, if the price had risen, you would have to repurchase the Bitcoin at the new market price, incurring a loss of $7,500.
A drawback of this method is that finding a party willing to lend you Bitcoin for short selling is almost impossible. Even if you find a willing party, they can recall the Bitcoin at any time, and you must accept the current market price.
The limitations of traditional short selling have led to a growing interest in derivatives as an alternative method for shorting Bitcoin. Derivatives are financial instruments whose value is derived from an underlying asset, in this case, Bitcoin.
With derivatives, there’s no need to borrow Bitcoin from third parties; you simply speculate on the future direction of the market. One example of derivatives is a Contract for Difference (CFD). CFDs represent an agreement to pay the difference between the price of a Bitcoin at the opening of the position and the price at the time of closing. When you anticipate a decrease in Bitcoin’s value, you open a position to sell one Bitcoin. CFDs are leveraged products, meaning you only need a small initial deposit, or margin, to obtain full market exposure. While margin trading can increase profits when the market drops, it can also result in additional losses if the market turns against you.
Suppose you chose to open a position for short selling Bitcoin through CFDs. If, in our previous example, Bitcoin was trading at $40,000, you could open a position to sell one BTC. If your provider’s rate is 50%, you would only need to deposit $20,000.
If the price indeed drops, as predicted, you would close your position by selling one BTC at the new price of $32,500. Your profit would be the difference between the opening and closing prices, in this case, $40,000 – $32,500 = $7,500. It’s important to note that any profit from your CFD transaction is calculated based on the entire value of your position, not just the deposit.
However, if the market had risen to $47,500, you would have to buy one Bitcoin at the new market price, resulting in a $7,500 loss on the CFD transaction.
Step 2: Managing Your Risk
The increased popularity of short selling has created even more downward pressure on Bitcoin’s price, as more people participate in the short-selling trend. However, it’s essential to remember that short selling carries risks.
The primary risk in short selling is the potential for unlimited losses. When you buy Bitcoin, your loss is limited to the amount you paid for the cryptocurrency. However, when you sell Bitcoin, there’s no limit to the possible negative market movement and, consequently, your potential loss.
Therefore, learning to manage your risk is crucial before you start trading. If you’re using derivatives, you can add a guaranteed stop to your Bitcoin position, protecting your trade in the event of an adverse market move.
Several factors can cause the price of cryptocurrency to change rapidly and dramatically. While many investors in the Bitcoin market are attracted to this volatility, it’s also a cause for concern if they lack a proper risk management strategy.
Step 3: Opening Your First Position and Monitoring the Market
Once you’ve decided on how to protect yourself, it’s time to open your first short-selling position. It’s crucial to stay vigilant for any developments that could lead to a sudden movement in Bitcoin’s price.
Summing Up Shorting Bitcoin
Before you engage in short selling Bitcoin, understanding the process and associated risks is crucial. Here are some key points summarized:
- Shorting involves borrowing Bitcoin to sell it on the market and then repurchasing it at a lower price.
- Investors do this with the hope of profiting from the price difference.
- Investors short Bitcoin for speculation or hedging purposes.
- There are different methods for shorting Bitcoin, including selling through a broker and using derivatives like CFDs.
- Short selling comes with risks, so it’s essential to develop a risk management strategy.
- After opening your first short-selling position, stay informed about any changes in the Bitcoin market through news and analyses.