The majority of Bitcoin investors are what are known as ‘HODLers’ – a colloquial term that is either a mis-spelling of HOLD or an abbreviation of “Hold On for Dear Life”.
To ‘HODL‘ means to simply purchase a set amount of Bitcoin (or other cryptocurrency) and keep it in the hopes that it will increase in value. It is the simplest and most common form of asset investment, both traditionally and within the cryptocurrency market.
However, to fully realize the maximum profit potential of any market, a savvy investor should also learn how to ‘short’ the market and in this guide we will cover clearly and simply how to short Bitcoin. Short selling is the art of selling a ‘borrowed’ asset at a certain price with the aim of re-purchasing it when the price of the asset has dropped.
- Let’s say one Bitcoin is worth $1,000.
- Via a crypto trading platform or exchange, you ‘borrow’ 5 Bitcoin. You now owe the platform 5 Bitcoin.
- You immediately sell those Bitcoin for $5,000 and now have $5,000 in cash.
- The next day the price drops to $800 per Bitcoin. Using your $5,000 cash you buy back 5 Bitcoin for $4,000 and pay off your debt to the platform.
- You end up with a $1,000 profit.
As you can see, the main advantage of shorting an asset is that you can make money even when the market is crashing. This means that while everyone else is crying into their coffee, you can be counting your profits.
Naturally, if your prediction is wrong and the price does not go down then you could end up in debt. Unlike buying physical assets, short orders don’t last forever. If the market doesn’t move in your favor before your order expires, you lose your money. This is called getting liquidated.
In order to successfully short the market, you will first need to have a relatively good understanding of market movements.
With that said, let’s have a look at the basic steps of how to short Bitcoin.
How to short sell Bitcoin
1. Sign up to a Bitcoin trading platform
Unlike with passive investing, you can’t make money from the market by simply buying some Bitcoin and putting it in a digital wallet. To short sell Bitcoin, you will need to sign up with an online cryptocurrency trading platform or exchange.
There are several of these platforms available, but one of the longest running and most reliable ones is eToro. eToro recently added an expansive list of cryptocurrency trading tools to its popular online asset trading platform.
2. Open a Short Position
Once you have signed up, simply select the amount of Bitcoin you would like to sell and then open your short position. The method to do this should be relatively similar across most trading platforms but usually involves selecting the ‘Sell’ rather than ‘Buy’ option. There are also various additional options available when shorting that we’ll discuss in a bit.
Once selected, the online trading platform will automatically sell the Bitcoin for you at current rates and then ‘credit’ you with the cash value. Some platforms also offer the ability to short Bitcoin using a contract for difference (CFD). This is essentially just a simplified method of achieving the same result.
3. Close your Short position
You can’t withdraw your credit as cash until you either choose to close your position or it expires automatically. At that point, any profit you have made will be awarded to your trading account.
In the event that the position closes negatively, any funds that you have in your account will be used to cover the loss (or you will go into debt with the platform).
Keep in mind that the platform you are using has the option to close or cancel your position at any time. However, most platforms will operate fair time periods during which positions can run their course in order to keep customers happy.
Continue reading below for tips on when the best time is to open and close short positions.
Options available in short selling Bitcoin
There are various different options you can select when shorting Bitcoin that will help you to maximize your profits and minimize your losses. Depending on the platform that you choose to use you may have access to different selections of options, but the most common are stop-loss and leverage.
Stop-loss is the most important tool to use when short selling Bitcoin. You can use stop-loss to set a specific limit to the amount you can afford to lose. If Bitcoin suddenly shoots up in price instead of dropping, then you could lose hundreds or even thousands of dollars on a trade.
Always set your stop-loss at a decent value to ensure that you cut your losses before you go broke. However, don’t make your stop-loss so small that your position closes before having a chance to reverse. Between 15 to 20 percent of your total position is generally considered a good amount for stop-loss.
There is a significant amount of discussion in financial circles regarding the most profitable stop-loss strategies. As you become a more experienced trader, you will discover which strategy works best for you.
Leverage is an option you can select that gives you the potential to maximize your profits. It basically means you can open a short position for more Bitcoin than you have the money to cover, under the confident belief that your short position will be filled.
Leverage is usually indicated as a multiple (2x) or ratio (2:1). 2x leverage means you can stake twice as much as you have available in funds.
You choose to short $100 worth of Bitcoin at 2x leverage, meaning you’ve now shorted $200 worth. Bitcoin drops by 50% and you close, making yourself $150 in profit. Without the leverage, you would have made only $50.
However, if Bitcoin goes up by 50% and your position closes, you lose $150 – leaving you $50 in debt. Without the leverage, you would have only lost $50 and still had $50 credit in your account (credit in your account is known as equity).
Due to the potentially huge losses involved, not all customers will be eligible for leverage – especially if they are new to a certain platform or have low equity.
NB: Leverage is an incredibly risky instrument to use as it could result in you falling into more debt than you can afford to cover. Only very experienced traders should add leverage to their short positions – it is literally gambling with money that you don’t have!
When should I short the market?
As the old saying goes: “What goes up, must come down.”
Generally speaking, if any stock or asset consistently increases in value for an extended period of time, it becomes more and more likely to start going into a downward trend. Traders and analysts refer to assets that have increased in value too much as ‘overbought’ and use technical indicators like the Relative Strength Index (RSI) to predict when they might start dropping.
However, you don’t need to understand complex technical instruments in order to get a good feel for the market. Keeping an eye on the news and developments in the industry can often offer clues to incoming price drops.
Bitcoin tends to experience drops in price following negative news such as major exchange hacks, overly-restrictive government regulations or controversial hard-forks of the network. However, not all negative news makes the price go down. More often than not, when traditional stock market traders denounce Bitcoin as a scam, the market actually improves.
The best advice is to keep an eye on financial and political developments from around the world and research any changes in the technology that Bitcoin is built upon.