What is short strategy in crypto trading?
“Going short” is a technique used when an investor sells an asset in an anticipation to buy it later. Thus, as any other profit in crypto, the profit from going short benefits from a price decrease, normally, after a long bull run.
Ways to go short
Margin trading
This involves the trader borrowing an asset in anticipation of a price drop, selling it at a higher price, and then buying back once the price has decreased. To borrow an asset, traders can use a crypto exchange that connects them with a lender or directly borrow assets, usually with interest rates. Thus, the trader is limited only by the borrowing limits set by a specific exchange.
This is the most famous shorting method due to the ability to trade with more assets than you have. However, it has its shortcomings such as commissions and interest rates that reduce the trader’s profit.
Futures
Futures are considered to be contracts that require a trader to purchase an asset at a particular price on a particular day. But in crypto, the sale of futures doesn’t involve direct ownership of the coin.
Shorting crypto futures (or, selling them) means to bet on a price decrease on a predetermined date, at a pre-established price, and requires a contract between two parties.
Some futures exchanges enable you to directly deal with the amount of profit or loss prices in fiat money. This is a method that is still gaining popularity, but it is not as advanced as others.
Contract for Difference (CFD)
CFDs are derivatives that enable investors to speculate on the value of underlying assets without having to own that asset. Due to the volatility in crypto markets, CFDs are considered to be the best and least risky way to trade digital assets. CFDs perform closer to fiat money since they are not cryptocurrencies in themselves. This indicates that the trader does not need to bother about the liquidity of an asset (such as Bitcoin) since a CFDs measure price differences of an asset.
Direct Short Selling
In contrast to the methods mentioned above, Direct Short Selling requires ownership and actual sale of the coin. The trader will aim to sell at a high price, purchase at low, and work from there based off of market fluctuations.
This strategy requires an initial purchase of the asset. It is important that if the transaction does not work, it will result in the loss of the actual asset.
The process of direct shorting is a little easier in automated trading because it enables you to deal with higher values, but this still amounts to slower profits and a considerable risk factor.
In addition to the fall in the price of the coin, it must also subsequently rebound, otherwise, the trader is left with a low-price asset, and the short-circuit profit is cancelled out by the loss of the asset's value.
Risks and benefits of going short
If a trader decides to bet against an asset, it can bring him a good profit, especially if he expects the price to fall at the end of a long uptrend. If we analyze charts and predict that the price will still fall, that will bring more opportunities for short investments.
However, being on the losing side of shorting, except it is done directly, hasn’t got any limitations on the potential loss to which a person is exposed. As the price of the borrowed asset may rise, and the trader is restricted by time limits to return the asset, he will probably have to buy the asset at a higher price than forecasted.
Due to the above-mentioned market volatility, it may happen that the final loss will damage the entire portfolio.
What to do?
If a trader still decides to short crypto assets, he has to take several things into account. The most important of them is money management. For instance, if you choose margin trading it is easy to bet with borrowed assets, but you need to consider a possibility of unexpected and potentially large losses. The trader must have installed limits to guarantee that any damage caused by shorting is covered by the entire portfolio.
Another very important thing is the choice of asset. It may be attractive to work with numerous assets at a time, but the fact that many coins trace each other's behaviour in the cryptocurrency market needs to be taken into account. This makes it potentially unsafe to short various coins that you expect to be in the same trend.
The last important thing here is that the trader should be careful in following the market. If the traders using the short strategy opt for buying back, the price surge that will follow can land the slower traders in an extremely unfavorable position.