In financial jargon, taking a short position in an asset means making a profit when the price goes down. This is just the opposite of the more common long position in which the trader will make a profit when the value of the asset rises. What really the trader does is, first sell the asset and then repurchase it at a lower price. A trader executes a short position being sure that the prices of that particular asset will fall in near future. Commonly what the trader who is trading in the conventional stock market is, borrow the stocks from a broker and then sell them. Then within a certain period when the prices of the stocks decrease, buy them at a lower value to book profits.
Presently many cryptocurrency exchanges are allowing traders to short Bitcoins and other cryptos. Using this strategy a trader borrows a certain amount of Bitcoins from the electronic trading platform on a margin. Then when the prices go down, the trader sells the digital currency. The trading platform takes the amount lent and transfers the profit amounting to the difference of sell and buyback value to the trader.
Before starting to short in Bitcoins the trader should understand the underlying blockchain technology. There should also be a proper trading strategy as the market is somewhat unpredictable. The only perception of a probable bearish market may not be sufficient to execute the winning trades. Many cryptocurrency bulls short in Bitcoins believing it has long-term potential. Also, the traders in Bitcoins who may be owning this asset hedge their holdings with short-selling. They believe that its value will decrease in the near future and may short to reduce the loss of market downfall. This way, if the prices of Bitcoins fall, the value of holding may decrease, but the profits made from short-selling will balance it off.
Blockchain-based Bitcoin was first introduced by Satoshi Nakamoto in 2009 and from the beginning, it became popular as a mode of payment. Because of its decentralized nature, it is free from the control of central banks. So, changes in the rates of bank interests cannot move the prices of cryptocurrencies. But several factors like the supply of Bitcoins into the blockchain, public perception for cryptocurrencies, or decisions by regulatory institutions impact its prices. Keeping all this in mind, the traders hope to book profit from the difference in prices of Bitcoins and execute short-trades. Presently many crypto exchanges like Kraken, Bitmex, Bitfinex, etc. allow shorting in Bitcoins using their trading platforms. Short selling in Bitcoins has its own share of risks and a trader needs to have a risk management strategy also.
There are many ways in which a trader can take a short position in Bitcoin.
In the traditional stock market, margin trading means a technique using which the individual traders buy more stock than they can pay for. The broker allows the trader to buy stocks by paying a marginal amount. Only, the trader should have a margin account and pay the margin value in cash or securities. The broker then buys the stocks and keeps them as collateral until the margin is settled by squaring off the position. The trade is required to be completed or squared off during the day or the trading session. This is also called leveraging positions and when the trade is squared off the profit is much more, otherwise, there is a loss.
Similar is the process with Bitcoins. Being a blockchain-based digital currency, shorting with margins in Bitcoins is easy. And with the arrival of sophisticated electronic exchanges and trading platforms to everyone, the trader has to choose one that provides this service. Then the client should place a request for a margin trading facility. Usually, before the broker approves the client’s request for margin trading, an amount of money is to be kept as a reserve which is called the minimum margin (MM). The broker keeps this amount to recover the loss if the trader loses the speculative short trade and fails to pay back the money.
After the electronic margin trading account is opened with a cryptocurrency trading broker, an initial margin (IM) is required to be paid by the trader. IM is a fixed percentage of the total traded value that is calculated by the broker. After the account becomes operational, the trader needs to maintain MM during the trade session. This is because on the days when Bitcoin price is more volatile the prices can fall drastically and the loss may be more than MM.
Practically, the full process is very easy even for amateur traders. The trader has to login into the electronic trading platform, borrow funds from the broker, and take short positions in the cryptocurrency market. During the session, the trader must close the position and book profit or loss. In case, the trader is unable to book profit or close the position during the trading session, the broker sells the cryptocurrencies kept as securities. Then, if there is a loss, the amount is collected from the trader’s account, and in the case of a profit, the money is transferred to the trader.
At the time of going to press, many Bitcoin exchanges permit margin trading like Binance, Kraken, Coinbase, etc.
Similar to other assets like stocks or currency pairs, futures trading is also possible in Bitcoins under similar conditions. The futures market is also called a futures contract or an agreement between a buyer and a seller of the contract price of any asset including stocks, commodities, or Bitcoin. The contract is such that the asset will be bought or sold for a pre-decided price on a specific date that should be in the future. The predetermined price that the parties decide is called the forward price. This date is called the delivery or expiration date. And the marketplaces where the negotiations are done between the buyer and the seller are called the futures exchanges.
Futures trading in Bitcoins also has futures exchanges where the contract is agreed upon between a buyer and a seller. The buyer may speculate that the price of the cryptocurrency will rise and so specify a contract price of the crypto and the date. The trader can also sell a futures contract speculating a bearish market and predicting that Bitcoin prices will decline. Merkle has published a study on the futures contract that suggests that selling in a Bitcoin futures contract is the best way to short the crypto. The increasing profitability and traded volumes in the selling futures contract have raised the demand for this type of trading. Therefore, brokerage platforms and crypto exchanges are offering the facility to their clients. Big exchanges like BitMex and Kraken and electronic crypto trading platforms or digital brokers like TD Ameritrade and eToro are also offering Bitcoin futures to traders
Binary Option Trading
Binary means two and binary options trading has two payoff options, a fixed amount or nothing. No other settlement is possible for the trader. In binary option trading, the trader has to assume whether the asset involved will reach above a specific price at a specific time. In this type of trade, the traders decide whether the answer is yes or no, and then place the trade. This is a simple trade and so it appeals to the majority of the traders including traders who are a novice to the financial market.
Binary trading has been very popular in the stock market and it did not take much time to migrate to the cryptocurrency trading world. Before starting binary option trading, the traders should know how it works, which exchanges and trading platforms allow this option, what are the time frames for trading with binary options, the pros, and cons.
The two options available in binary trading are call and put. The crypto that is being traded is called the underlying asset. A call buyer will make a profit when the underlying asset’s price increases. For a put trader, the trade is the opposite. A put option will give the trader the right to sell the cryptocurrency at a certain price before the expiration date.
An example may explain binary trading more clearly. Say, a trader is given the choice of two options to invest. One is for the Bitcoin price of $4000 at that time (say, at 9.30 am), either the trader invests in the price more than $4000 by 4 pm or less than $4000 by 4 pm. If before 4 pm, the price of Bitcoin crosses $4000, then the call trader will make a profit, but if it goes below $4000, make a loss. For a put trader, it is just the opposite. The trader invests in the decrease in the original price and earns a profit when the price is below $4000 before 4 pm.
Using these call and put options, traders can short Bitcoins also and make a quick profit. What the trader needs is a Bitcoin binary options trading platform or broker, knowledge of the market that can also be provided by the trading platform, and trading discipline. Binary options are now allowed through many offshore exchanges which have some charges and fees.
Binary option trading seems lucrative for traders as even the beginners can execute such trade and make huge gains. As there are only two outcomes of short trading Bitcoins with binary option trading, either the trader makes a certain profit or a certain loss. So the risks of such a trade are already known to the Bitcoin traders.
Another method of shorting positions in the Bitcoin market is through the predictions markets. Even though this way is a new technique for shorting Bitcoin and hasn’t been used in the crypto world for long, it can be an asset. These markets provide a unique feature to investors as they can develop a wager to create a wager on the basis of the outcome. And hence, if an investor predicts that the value of Bitcoin might fall by a specific percentage or margin, and if others challenge this bet, they will profit if the value actually decreases. One of the examples of a prediction market for Bitcoin is Predictious.
There are other platforms as well that allow investors to hold positions in the market, be it short or long positions. Stox and Augur are two platforms that allow investors to hold positions exclusively in the ETH market. To short positions in the Bitcoin market or in any other market, the investor needs to have a lot of heart, as they are generally going against the market trends. Having said that, if they are correct in their speculations, they can end up earning massive profits.
Short-Selling Bitcoin Assets
This method might not sound appealing to most investors but those who are interested in purchasing and selling the digital asset can short-sell the crypto directly. They can sell off the tokens at the price they are comfortable at, wait until the price of Bitcoin falls, and purchase the tokens again. And, it goes without saying that if the price doesn’t come down as much as the investor had expected, or goes up, for that matter, they stand a chance to lose Bitcoin assets.
Now, here is an example for readers to understand short-selling better. If a crypto investor believes that the price of Bitcoin is overvalued at $35,000 due to some reason, say recently executed the halving process, and they borrow 5 units at the current price from their broker. Suppose, their prediction, that the market will fall in the future comes true, and the value reduces to $30,000. Then, they can square-off their position with the broker by purchasing 5 units of Bitcoin at $30,000. So, here, they are actually returning the “borrowed” Bitcoins to their broker and making a profit of $25,000 ($175,000-$150,000). But if they are incorrect in their speculation and the value of each Bitcoin rises to, suppose $40,000, they will lose $25,000 ($175,000-$200,000).