Although there are some differences between stock trading and crypto trading, there are a lot of similarities. For example, both allow traders to short sell assets.
In this article, Changelly PRO will explain what shorting is, the risks it involves, and talk about some basic short trading strategies.
Short Selling Definition
Shorting, or short selling, refers to the practice of selling assets to buy them later at a lower price. Traders who enter short sales are typically bearish on the asset they are selling, meaning they expect its price to fall. Short positions are the opposite of long positions, wherein traders are bullish on the asset, expecting its price to rise, so they buy it now to sell later at a higher price.
Often, the assets that are sold are borrowed and do not belong to the trader. That is why on many exchanges, short selling is available alongside margin.
Let’s say you have done some technical analysis and have come to the conclusion that LINK price will fall in the near future. You do not own any LINK, but you want to capitalize on your findings. You short sell 1000 LINK at a price of $14, borrowing the cryptocurrency from an exchange, and buy it back at the price of $10 a few days later. You just made a $4k profit without ever owning any LINK.
One of the main risks of short selling is the danger of an asset’s price never falling, at least in the foreseeable future.
When you’re long on an asset, your potential loss is only as big as the size of your initial investment. However, when you’re shorting a borrowed asset, your loss will depend on how high the price will go, which is technically infinite. In reality, your position will most likely be liquidated before your losses get too big, but the danger is still there. If the price rises too high, then your position will most likely be closed, either by you (out of fear of further loss) or by the exchange.
Short squeeze is a risk that is unique to short selling. It occurs when the price of an asset suddenly spikes up. Short selling relies on the prices declining, so when they go up instead, many traders’ positions are closed because they either had a stop-loss order, borrowed funds from an exchange and so their position got forcefully liquidated, or because the trader themselves closed the position out of fear of bigger losses. As short sellers close their positions, the price rises even further. The more short sellers for a particular asset there are at a certain moment in time, the easier it is to create a short squeeze.
Let’s take a look at our previous example again. Imagine a scenario where your analysis turned out to be wrong – and instead of falling, LINK price started to rise with no signs of stopping. You decide not to risk it, and buy LINK back at the price of $18, losing $4000 in the process. Alternatively, let’s say you were unable to check up on the market, and while you were away, your position got liquidated by the exchange at the price of $25, resulting in an even bigger loss. You could’ve avoided this if you put a stop-loss order at $16, although you would’ve still lost a fraction of your funds.
Short selling is a more advanced trading strategy, one that requires traders to be able to study and analyze the market. Before you begin short trading, we highly recommend you not only gain some general trading experience, but also thoroughly research the risks associated with shorting. In addition to that, remember to start small, and work your way up.
Short selling lets traders make a profit even when the market is on the decline, so the main strategy is to look for cryptocurrencies that you think may fall in price in the near future. That can be done by either reading analysis carried out by professionals, keeping up with crypto news, or analyzing the market yourself. Either way, keep a close eye on your position, as with how volatile cryptocurrency is, you can lose your funds in a matter of hours if not minutes.
One general advice is to use stop-loss orders. When you do, your position will be closed – you will buy back your asset – at a predetermined price. This can be useful both when you’re just starting out and when you’re an experienced trader, as it protects you from big losses. The price can rise for an insignificant amount before it declines, so we do not recommend using stop-loss orders that are too close to the price you opened your position at.
Long/short ratios are a great tool of keeping an eye out for short squeezes – if there are significantly more short positions on an asset than there are long positions, it can be a sign that the price will spike up soon.
Changelly PRO is a great launching pad if you’re looking to try out short selling. In addition to having favourable fees and great rates, our platform offers an intuitive interface that displays risk percentage and unrealised profit and loss for all open positions – great tools for novice traders. We also offer stop-loss orders, which are a great risk mitigation tool. Start your journey into the world of advanced trading strategies with Changelly PRO!