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What is Short Selling? Basic Definition

A controversial topic that traders might read at a time when the market is bearish especially in cryptocurrency. Short Selling is a technique that has been around for quite some time now. But wait, before starting this discussion, it’s a trading strategy that should be undertaken by experts only. Don’t play random short-term games with your hard-earned money.

As a Hedge

To understand how Short-Selling works, first let’s be clear that it is not any form of investment into assets. Traders essentially speculate on the price drop of any security/stock/cryptocurrency. Sometimes, it can act as a hedge against a long position in the same security against the same asset. Now you might ask me, what’s hedging? In simple words, hedging is a technique used to offset the risk or reduce it by an alternate position against your own positions in the market.

Now, how it works?

In short selling, traders borrow shares or crypto tokens from a broker. Now, from here on I’ll explain further with a perspective to Cryptocurrency trading. So please hold on, it might sound a bit confusing at first but trust me it is very simple.

So, how do you open a short position? You’ll borrow crypto from your broker in the hope of repaying it back with interest when the price of that same token falls over the next few days or weeks or months. After the price falls, you plan on buying it back from the market at a lower price and pay it back keeping your own profits in the process.

The risk of loss on a short position is practically unlimited since the price of crypto might jump 20% or 30% in a day and then and there your position will be liquidated or you’ll be in a huge loss instantly. Now that might raise some eyebrows as to why people even do these trades? Well, there are reasons why Short Selling isn’t always as bad as it may seem. If you can time the market well and place trade according to the market cycle, you can make some pretty good money in the process.

For instance, as of today when I’m writing this, the market is down all-together. If I take any specific coin, eg Matic. Matic is down almost 15% in last 24h. If someone had a 10x leveraged short positing on Matic, that person would have made some pretty good profit.

But wait, that doesn’t mean you should do the same without proper research.

Key Points to Remember

  • You’re borrowing crypto assets when you open a short position, planning to buy the crypto back later for less money when the price drops.
  • You’re betting on a drop in crypto’s price eg, SXP/Matic/BTC. This is totally opposite with long where investors want the price to go up.
  • If you’re leveraged up, your profits can be in multiples and the same with your losses.

Understanding how this works.

To open a short position, you need to have a broker which allows you to have a margin account. For example, in Binance you can have one. After that you need to pay interest on the value of the borrowed crypto while your position is open. This is decided based on a pre-disclosed rate from your broker and it’s kind of similar to taking a loan. If the value of your account falls below the required margin, or more funds are needed your trade can be closed by Binance and you’ll be liquidated.

Profits & Losses

To book a profit on your short position, you can buy back the crypto probably at a lower price later on and return the borrowed crypto back making a profit on the price difference for your trade. For example, if you borrowed 1000 Matic tokens at a $1 price and now the price is $0.50 for instance, you can choose to close your short position and buy 1000 Matic tokens at $500 and pay back your broker and keep the rest of the money. ($1*1000 – $0.50*1000 = $500).

But on the other hand, if you’re leveraged up to 10x, and the same happened, you would have made $5000 in the same trade. Wait, that sounds fascinating, right? But it isn’t that easy. If Matic went up in price, you would have lost money the exact reverse way, maybe your entire money if you were leveraged up. That’s the risk.

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Pros and Cons of Short Selling

It can be really costly if your guesses are wrong about price movement. A trader who bought crypto in the spot market can only lose 100% of their money if the price plummets to absolute zero but a short seller can lose much more than 100% of their original investment.

Pros

  • The expectation of High Profits
  • Low Capital needed for funding
  • Leveraging possible against collateral
  • Acts as a Hedge to other positions

Cons

  • Practically Unlimited Losses.
  • Unnecessary extra fees and interest amounts.
  • High Risk & dangerous for new folks.

Ending Thoughts

The ideal time to open a short position is during a bear market when prices tend to plummet in crypto. The bear market is an ideal time to make money by placing a short position. However, if you aren’t in the market for more than 2-3 years, you should not try margin trading or leverage trading as it’s very risky with potentially unlimited losses. Finally, it all comes down to doing your own research.

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