What is a short position in crypto trading - when to open & close it?
There are many different trading strategies, which can be employed when trading cryptocurrency. As an investor, it’s important to know your options, and once you do, you can either stick to one style or even take advantage of several different ones.
In today’s article, we’re going to be talking about short positions and how you can take advantage of them. What is short trading, and how do you use it effectively? Let’s find out, but first, we need to define what a short position in cryptocurrency is.
What does cryptocurrency short position mean?
A short position is used when you believe that the crypto market is going to be moving down. You could think of this as betting against an asset instead of for it. A short position doesn’t even necessarily mean that you don’t believe an asset has potential.
In fact, a short is often playing a temporary decrease to your advantage. In short positions you sell now and buy later. This can be used with or without margin, but newbie investors should be very careful playing in unknown waters with money that is not theirs.
What duration short position in crypto usually has?
Technically, you could hold a short forever, but the idea is to end up with more coins than you had before. While a short trade could last as long as you wanted, most traders will hold these positions for a few months, or possibly less.
If you are typically a long-term trader (positions over a year), then you should keep in mind that there will be very different tax consequences for short trading, and you’ll need to make sure your income records are up to date and that you are withholding enough money to cover your debt to your local tax authority. If you make money from a sale, and then you lose it again, keep in mind that you still owe taxes on the first big win.
Example of a cryptocurrency short position
Jimmy believes that the current crypto market is a bubble waiting to pop. He decides that Bitcoin is ready for a major decline, and he wants to short it. He borrows some coins from the exchange or brokerage on margin and sells them.
As he believed, the market begins to decline, and the price of Bitcoin drops. Using the profit he made from the short, he can now buy back more Bitcoin than he had, pay back the exchange and still take a profit.
When to open a short position?
You should open a short position in cryptocurrency trading when you believe that the market will be falling in value. This could be based on a number of factors which you can try to identify such as massive volume spikes over a short period, a run-up in prices or even overly optimistic news. Someone who is shorting will open a position when they believe that an asset is trading above what they believe it is actually worth.
When to close a short position?
You should close a short position when you see that the market is going into recovery. It can sometimes be difficult to judge the crypto bottom, but the good news is that with a short, you’ve already made your profit. You’re simply waiting for the price to fall so you can gain more of whatever cryptocurrency you’re shorting.
How to close a short position?
Closing a short works pretty much the same way as closing any other position. You sell the asset, and the sale is recorded. If you purchased that asset on margin from the brokerage, then you’ll also need to purchase the same amount of coins or tokens that were loaned to you and return them to the brokerage.
Is short position crypto trading good or bad?
Shorting can be very good, but it’s also a pretty tough game. This is doubly true if you’re planning to trade with borrowed funds. If you don’t yet know what you’re doing, then this is not recommended at all. You could end up in debt to your broker for a lot of money with no way to pay it back.
It’s best to save trades made like this for when you’re more experienced. Learning to short properly, however, can end up giving you an excellent new tool for your trading arsenal that can ease the pain of bear markets if you can learn to identify when they’re coming.
What risks cryptocurrency short trading has?
If you are shorting your own cryptocurrency, then short trading has less risk involved. Though you are limiting your profit potential, and if the price of Bitcoin, for example, were to rocket, then you would, of course, miss out on those profits.
That’s why it’s important to learn to identify when the market is in trouble and only short then. If you are trading on margin from a brokerage, then this risk is amplified. If you don’t know what you’re doing it’s possible that you could end up in debt.
A short technically gives you a limited reward vs unlimited risk, though this “unlimited risk” is based on the fact that if you’re wrong you could lose out on potentially limitless amount of profit since the price of Bitcoin could theoretically just keep going up. It’s up to you to decide if these risks make short trading worthwhile for you.
Short versus long crypto trading
Investors entering into a long position believe that the price of the asset or even the entire market will continue to climb. They make money by gathering this price appreciation and then selling at a later date. Short traders make money by betting that the market will be going down.
They make money by either shorting their own positions, or borrowing money from a broker to sell assets, and then buy them back later at a cheaper price. It’s possible to employ both long and short position trading in your cryptocurrency strategy if you learn to identify key points in the market cycle.