Short selling bitcoin: a how-to guide
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.
What is shorting bitcoin?
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.
Can you short sell bitcoin?
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.
Why should I short sell bitcoin?
Figuring out if you should short sell bitcoin depends on your motives. Many traders short-sell bitcoin for numerous reasons, including the following:
- Valuation. Investors who speculate that bitcoin is overvalued or exists in a price bubble may wait for a downward trend to start before shorting bitcoin. Traders who trade bitcoin based on valuation metrics predominantly follow a fundamental trading style, analysing the suspected intrinsic value of an asset against its market price.
- Hedging risk. Some traders short assets to hedge the risk of their larger portfolio. For example, if you already hold bitcoin but you suspect it is due to fall in the short term, you may decide to open a position to short sell bitcoin. If you are correct, the profit from your short position can reduce or exceed your loss from your long position.
- Scepticism. Some traders that short bitcoin expect cryptocurrencies to be a short-term trend and hold bearish sentiments towards the bitcoin market. These short-sellers tend to stay up to date with the latest bitcoin and blockchain advancements and not let opinions interfere with their objectivity.
- Volatility. Evident from its history, the price of bitcoin can appreciate as quickly as it depreciates. Traders with a high-risk appetite are drawn to volatile assets that have the potential to reap huge rewards, or equally huge losses. However, whilst some traders rely on luck, others utilise a structured approach based on experience and knowledge.
Where can I short bitcoin?
There are several methods to short 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.
Bitcoin exchanges
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 whilst 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 bitcoin trading provider
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, and your profit or loss is dependent on if you are correct or not.
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 by asset class but is currently 50% when you trade on bitcoin with CMC Markets.
Shorting bitcoin on our leveraged trading platform comes with several different features when compared to shorting bitcoin on an exchange, such as:
- Both spread betting and CFD trading are exempt from stamp duty*
- Spread betting is exempt from capital gains tax*
- Opportunity to trade with leverage
- FCA regulated business
- Negative balance protection for retail clients
If you are interested to start leveraged trading, why not practise your trading strategies on a demo trading account with CMC Markets?
Make sure to visit our ‘Why CMC’ page to see what differentiates us from our competitors.
Bitcoin options
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
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.
How to short sell bitcoin
Follow our step-by-step walkthrough that covers how to short-sell bitcoin via a leveraged trading account. Please note that it is important to educate yourself on short selling, leveraged trading and the bitcoin market. A lack of knowledge in any of these areas would render you liable for making mistakes. New traders may benefit from practice on a demo account before risking any capital on a live trading account.
- Open an online trading account. Not sure which is best for you? Read about our products to find out more.
- Undertake analysis of the bitcoin market. It is key to study the bitcoin market using various types of analysis. See the differences between technical analysis and fundamental analysis here. Understanding the bitcoin market is essential to help define your market entry and exit points.
- Minimise your risk. When shorting bitcoin it is essential to follow your risk management strategy. Utilising risk management features such as take profit and stop-loss orders can ensure that your trading process remains structured and consistent.
- Go short and ‘sell’ bitcoin. Once you have determined that you want to short bitcoin, and have set the appropriate risk management conditions, go ahead and place your bitcoin trade.
Short selling bitcoin strategies
When shorting bitcoin, traders can use many types of analytical strategies. These strategies vary by type of analysis, time frame and risk appetite. However, a key decision traders make when they are starting out is if they are going to focus on technical or fundamental analysis strategies. Some traders utilise a blend of both, especially if both strategies suggest similar information.
Technical analysis
Traders who follow a strategy based upon technical analysis review historical BTC price charts by observing past trends and using technical indicators. The 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 whilst 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.
Fundamental analysis
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 is 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 to be cut in half every 4 years, 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 10 million USD (8 million GBP) the bitcoin creator ‘Satoshi Nakamoto’ supposedly holds**.
Things to watch out for when short selling bitcoin
Risk
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 a risk management conditions such as stop-losses.
Volatility
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 without reason or prediction, it can be best to withdraw from making any trading decisions unless they follow your trading plan. Read more here if you need help on creating a trading plan template.
Key takeaways
- Bitcoin, like many other assets, can be short sold. Revisit our ‘how to short bitcoin’ section to review a simplified version of how to do so.
- You can short bitcoin in several ways depending on your specific needs.
- It can be best to use a combination of technical and fundamental analysis when trading bitcoin. However, if you are starting out, you should learn one analytical discipline before moving on to the other.
- Although the potential for profit when trading bitcoin can be high, keep an eye out for the high levels of risks associated with shorting bitcoin, especially when trading with leverage.
*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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