Bitcoin (BTC) is an extremely volatile asset, characterised by unpredictable price swings and large price movements. Bitcoin’s value reached a high of over $19,000 (£14,000) but then fell to around $7,000 (£4,900) in a matter of months. Traders can attempt to take advantage of its volatile nature by short selling bitcoin. However, short selling is not for the novice trader as it carries different risks to buying bitcoin. This article will teach you how to short bitcoin, where you can do so and what to look out for.
When shorting bitcoin, the aim is to sell the cryptocurrency at a high price and buy it back at a lower price. Unlike most traders who like to buy low and sell high, short sellers adapt the order of this philosophy and aim to sell high and buy low. If they are correct and the price drops, the bitcoin trader profits from the price movement between when they sold the asset, and when they bought it back.
Yes, like other financial instruments, bitcoin is available to ‘sell’ and go short. However, short selling bitcoin can be a complex process and varies depending on whether you intend to use a cryptocurrency exchange or a leveraged trading provider.
Figuring out if you should short sell bitcoin depends on your motives. Many traders short-sell bitcoin for numerous reasons, including the following:
There are several methods to shorting bitcoin, each with its own level of complexity, risk and reward. However, the methods below are all categorised as types of derivative trading, except from the traditional method of shorting via an exchange.
The most common method of shorting bitcoin is through a market exchange that accepts the shorting of bitcoin. Many exchanges support the shorting of bitcoin such as Kraken, Bitfinex and Bitmex.
Exchanges that support the sale of bitcoin have an added level of complexity compared to buying and owning bitcoin. Bitcoin traders who speculate that the bitcoin market will fall can open a short position. However, they must borrow the cryptocurrency from a broker or another willing lender. Once they borrow the bitcoin, they sell it immediately.
If the price drops, traders can buy back the amount of bitcoin they borrowed at a lower price. The trader then returns the shares owed to the borrower while profiting from the price difference. However, if the price continues to increase, traders are exposed to an ‘unlimited loss’ scenario. As traders must buy back the shares they borrowed, and the price of bitcoin can hypothetically keep on rising - the hypothetical loss potential is unlimited. Please note that selling on an exchange can rely more on liquidity than buying, and is accompanied by borrowing fees, commissions and other costs. The complexity of shorting bitcoin on an exchange means that some traders prefer using a leveraged trading provider to open a short position on bitcoin.
Leveraged trading providers offer products such as CFDs (contacts for difference) and spread betting. Unlike exchanges, where you borrow the cryptocurrency, with leveraged trading products you do not own the underlying asset. Instead, you take a position on whether bitcoin’s price will rise or fall., Whether you make a profit or loss essentially depends on if you are correct in your view of the instrument's price direction.
Spread betting and CFD trading are both types of leveraged trading, meaning you are only required to lay a small deposit to gain exposure to the full trade value. However, as your exposure is based on your full trade value and not your deposit, your profit and losses are amplified in accordance with the full exposure. The deposit value differs depending on which asset class you trade. and is currently 50% when you trade on bitcoin with us.
Shorting bitcoin on our leveraged trading platform comes with several different features when compared to shorting bitcoin on an exchange, such as:
Some cryptocurrency exchanges offer bitcoin options. A bitcoin options contract provides you with the option (and not an obligation) to buy or sell bitcoin at a specified price within a specific date range. Options contracts are recommended for advanced traders due to their level of complexity and the use of leverage. They are, however, a flexible option for short selling bitcoin as you only initially risk the options contract premium.
Bitcoin futures are a legal contract that allows you to buy or sell bitcoin on a specific date, for a specified amount. When a bitcoin futures contract is taken out, the buyer (or seller) commits to buying (or selling) an agreed quantity of bitcoin at an agreed price on a particular date.
Futures contracts were initially created to shelter traders from price fluctuations that exist in commodity markets. However, the availability of a futures contract soon developed past commodities. Futures contracts can now be accessed from several asset classes, including cryptocurrencies such as bitcoin. Futures are, however, a complex financial contract and may be better suited for experienced traders.
Follow our step-by-step walkthrough that covers how to short-sell bitcoin via a leveraged trading account. Please note that it's important to educate yourself on short selling, leveraged trading and the bitcoin market. New traders are likely to benefit from practising on a demo account before risking capital on a live trading account.
When shorting bitcoin, traders can use many types of analytical strategies. These strategies vary by type of analysis, timeframe and risk appetite. However, a key decision for traders starting out is whether to focus on technical or fundamental analysis strategies. Some traders utilise a blend of both.
Traders who follow a strategy based on technical analysis review historical BTC price charts by observing past trends and using technical indicators. Moving average indicators help to reduce bitcoin’s volatile price history into a simple trend line. Moving averages encapsulate several indicators, but include SMA (simple moving average), MACD (moving average convergence divergence) and Bollinger Bands. The MACD is used to decipher the strength and momentum of a trend, while Bollinger Bands help to show if an instrument is overbought or oversold.
Other technical analysis strategies for shorting bitcoin include trading based on support and resistance levels and trading on chart patterns. Both strategies can work well and have their respective advantages and drawbacks.
Support and resistance levels can be relatively easy to identify but are less prominent when a market is rapidly increasing or declining, whereas chart patterns can be hard to identify and may contradict each other. However, chart patterns can be automatically identified with our pattern recognition scanner, complete with performance ratings to review past successes.
Some traders believe that bitcoin has no ‘fundamentals’ and should be traded using just technical analysis. Although the bitcoin market is relatively new and lacks the historical value of other assets, it's possible to apply fundamental analysis strategies to the cryptocurrency.
When using fundamental analysis strategies on bitcoin and other cryptocurrencies, traders could start with uncovering the driving forces behind its supply and demand. Variables that impact the demand of bitcoin include news, market sentiments, adoption, transactional activity and trading.
Supply variables are relatively simpler as we know that bitcoin has a finite amount. However, other factors such as bitcoin halving and the existence of ‘dead bitcoins’ can affect its supply. Bitcoin halving involves the block reward from mining being cut in half every 4 years, and therefore slowing down the overall supply. ‘Dead bitcoins’ are bitcoins that have been lost or are inactive. This might include the 1.1 million BTC worth in excess of $10m (£8m) the bitcoin creator ‘Satoshi Nakamoto’ supposedly holds**.
Since the price of bitcoin cannot fall below zero, there is a cap to how much profit can be made when shorting bitcoin, and the possibility of uncapped losses. This is inverse to the ‘going long’ risk scenario where risk is limited, and stocks have unlimited growth potential. Please note that losses associated with shorting bitcoin are unlimited in a hypothetical sense, as the price could hypothetically continue to grow in value. However, this is an extreme example and can be mitigated with risk-management conditions such as stop-losses.
When the price of bitcoin is rapidly fluctuating, you can generate profit just as quickly as you can incur losses. At times when the market is particularly volatile, it can be best to withdraw from making any trading decisions unless they follow your trading plan.
Read our creating a trading plan template article.
*Tax treatment depends on your individual circumstances. Tax law can change or may differ in a jurisdiction other than the UK.
**Price estimation correct as of 11/02/2020
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