The most popular way to invest in bitcoin is to buy and hold the digital currency. However, if you prefer a more active approach to your bitcoin investment and also want to profit when the market goes down, then this guide is for you as it details the best ways to short bitcoin.
What is “Shorting”?
Shorting, also known as going short, is a way of trading that allows investors to bet on the price decline of an asset or a security. Shorting is a very popular method among daytraders who trade highly volatile assets as it allows traders to benefit from strong price swings in both directions.
If you want to short bitcoin, you have several viable options to do so.
Short Selling on Exchanges
Traditionally, shorting refers to the short selling of a security. To short a security, you sell a security that you do not own so you first need to borrow that security. Then, once the price has declined and you have reached your profit target, you close out the short by buying the security to pay back the borrowed security. Hence, you have profited from the price decline minus a (relatively small) borrowing fee.
In the case of bitcoin, you can short sell the digital asset on exchanges such as Bitfinex or Poloniex. There, you sell bitcoin and then buy it back once the price has dropped enough for your price target to be hit. This is usually done using leverage to exasperate the profit (but also the loss if the trade goes the other way).
Selling Bitcoin Futures
Alternatively, you could also sell bitcoin futures contracts on the CME or the CBOE, provided your online broker has enabled the trading of these contracts for its customers. Futures contracts give the buyer the right to purchase an asset at a specific price on a predetermined date in the future.
That means if you sell bitcoin futures, you can bet on a price decline and close out your futures contract once the price has dropped or when the contract has expired.
Bitcoin Put Options
Another way to bet on the price of bitcoin declining is through bitcoin options, which are currently on several digital asset derivatives exchanges. Options provide traders with the right but not the obligation to buy/sell an underlying asset at a predetermined date and price.
Therefore, if you want to buy a bitcoin put option, which allows you to sell bitcoin at a specific price lower than its current price, you can make a trading profit when the price drops below that price and then close out the option by selling the bitcoin at the predetermined price and buying the bitcoin as a lower price. The difference between the two will make up your profit minus the (small) price of the put option.
Risks of Shorting Bitcoin
While profiting from a decline in the price of bitcoin may sound very appealing due to the digital asset’s high volatility, the reality is that shorting bitcoin is a very risky affair. Historically, the price of bitcoin has gone one way in the long-term, and that is up. Furthermore, as much as bitcoin has the tendency to drop by ten percent in a day, it also regularly rallies by ten percent or more in a day. If you go short, especially using leverage, and the price rallies, you can lose more than you originally invested and that can be very detrimental to your investment portfolio.
Hence, it is recommendable to only short bitcoin using small amounts of money and to ensure you have stop-loss limits in place so that you cannot lose more than you originally placed on that trade.
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