How to Short Crypto: Profit During Crashes and Retracements

Today’s cryptocurrency markets are intrinsically volatile. A currency that’s on a hike today might experience a dip tomorrow that you couldn’t have imagined. In fact, many cryptocurrencies’ prices constantly change throughout the day. 

Along with regulatory actions, crypto volatility can lead to fear-driven flash crashes and slight retracements after big rallies. To avoid experiencing losses when this happens, you can tap on a concept called short selling that allows you to make money when prices are falling — even without owning the underlying cryptocurrency that you’re short selling. In this article, we’ll explain cryptocurrency shorting, its associated risks and how to short cryptocurrency.

What Does Shorting Crypto Mean?

Shorting cryptocurrency is the process of selling crypto at a higher price with the aim of repurchasing it at a lower price later on, ideally in situations where a cryptocurrency’s price is expected to fall.

The reason it’s called short selling is that you’re “short” of the cryptocurrency. You don’t actually own the cryptocurrency that you intend to profit from. To understand shorting, you need to be familiar with cryptocurrency long and short positions. When you go long, it means that you’re buying cryptocurrency, expecting its market value to go higher. For instance, you buy Ethereum at $1,000 and expect its price to hit $1,200. You sell it once the price increases in order to make a profit of $200.

On the other hand, shorting means you borrow a cryptocurrency and sell it at the current market price, expecting it to fall. Then, you buy the cryptocurrency back when its price falls or retraces slightly, making a profit of the difference between your selling and buying prices.

Here’s an example:

• You intend to short 1 BTC (Bitcoin) when its value is $30,000, since you expect its price to fall in the next few days.

• You borrow a Bitcoin from a broker and sell it for $30,000.

• A few days after you borrow the Bitcoin, BTC’s price falls to $25,000.

• You buy a Bitcoin for $25,000 and return it to the broker.

• Now you’ve made a profit of $5,000, minus transaction fees plus any interest that you have to pay the broker for borrowing the Bitcoin.

Shorting is a way to make money off the decline in an asset’s value. Thus, traders can opt for shorting when they expect a cryptocurrency’s market value to decrease. Shorting cryptocurrency is a risky strategy, since markets are often unpredictable. Of course, there’s the potential for gains, but with the market’s volatility the likelihood of large losses is equally probable.

When you hold a long position, the cryptocurrency’s price might drop, but rarely to zero. Even though you don’t make any money, you still have your original investment, and you can hold onto your crypto until its price hopefully begins to rise again. When you’re shorting, a cryptocurrency’s price can rise indefinitely, increasing your losses. Hence, before shorting you need to have done your research, and have conviction that the asset’s price will drop.  

Marketplaces like Bybit are making it more straightforward for lenders and borrowers to find each other and capitalize on the soaring interest in cryptocurrency shorting. As the number of resources increases, short-selling cryptocurrency is becoming more accessible to traders.

Reasons for Short-Selling Crypto

Traders have different reasons for short-selling cryptocurrency, depending on how much they want to gain or the kind of analysis they’ve conducted. Following are some reasons for short-selling crypto.

Valuation

Sometimes, a particular cryptocurrency might be in a price bubble, or be overvalued at a specific point in time. This might be the result of project announcements, or certain narratives created by users within the cryptocurrency market. Traders may pick up on this trend, wanting to short-sell this hyped-up cryptocurrency for profit.

Therefore, they short this overvalued cryptocurrency and wait for its retracement to begin. When short-selling cryptocurrency according to valuation metrics, use a fundamental trading style to analyze the intrinsic value of a cryptocurrency against its current market price, so you’re aware of when you can buy back the borrowed cryptocurrency. This will provide you with a take-profit strategy.

Volatility

Cryptocurrency’s volatility might be a matter of concern for risk-averse investors, but traders can leverage this characteristic in order to make money. Historically, it’s evident that cryptocurrency pricing can rise just as quickly as it can fall.

Traders who have an appetite for risk are naturally drawn to these fluctuations since they offer potentially large rewards. Thus, if you’re knowledgeable about changing trends and have expertise in the field, you can use the cryptocurrency’s volatility to your advantage. Should a cryptocurrency experience significant price upside over a period of time, traders will typically look toward shorting it.

Hedging Risk

While cryptocurrency’s volatility might pave the way for short selling, it negatively affects long positions. For instance, if you already have Bitcoin, and you believe its price will soon fall, you can decide to short it to “protect” the long position that you’ve already opened.

If your predictions are correct, the profit you get from short-selling cryptocurrency can end up reducing or exceeding your long position’s loss. Simply put, having a hedging strategy in place minimizes your losses in a bear market. This is why some people say that one can profit regardless of the market direction.

What Are the Risks of Short-Selling Crypto?

Shorting cryptocurrency is definitely a way to make some extra money when the market is down or to hedge your portfolio, but you need to consider its risks, too. Below are some notable downsides to shorting cryptocurrency.

Limitless Losses

When you buy and hold cryptocurrency in the hopes of selling it for a higher price in the future, you’re only exposed to the risk of ending up with a currency that didn’t reach the price you wanted it to.

At the end of the day, you still have your cryptocurrency, and can continue to hold it for as long as you wish.

On the other hand, your potential losses are limitless with shorting cryptocurrency, since they go beyond your initial investment. If the currency price keeps rising, you might have to borrow it at a higher price to lower your average cost if you’re intent on covering without incurring losses.

However, when you are shorting a cryptocurrency, your potential losses are limitless when the cryptocurrency price keeps on increasing. To cover the losses incurred while shorting, a trader will have to continue to short the cryptocurrency when the price increases. This will lower the average cost of borrowing the cryptocurrency.

Margin Interest

Bear in mind that when you short sell cryptocurrency, you don’t actually own it. Instead, you’re borrowing it from a broker, who charges you interest as long as you hold the coins.

Suppose the currency’s price doesn’t decrease per your predictions. You may end up having to sit on it for a long time. While this stagnation or rise is taking place, the interest keeps piling up, eating a chunk of your profits. If the cryptocurrency’s price keeps increasing and you decide to cut your loss, you’ll not only lose out from the price increase, but will also have to pay a hefty cost (in interest) for short selling.

How to Short Cryptocurrency

Before you use any method to short-sell cryptocurrency, you first need to find a trend. Since the market is highly volatile, many factors can send it in either direction. For instance, politics, hype culture and the influence of notable people, such as Twitter key opinion leaders (KOL), can disrupt the cryptocurrency market.

If you want to know how to short sell a cryptocurrency, make sure you study its trends, such as sudden interest on the part of a high-end company or billionaire. After that, you have to open your margin trading account. Most cryptocurrency brokers have the accommodations for short selling. However, you also need to check your country’s regulations to ensure you’re not challenging any legal guidelines.

Now you know what shorting in cryptocurrency is. Let’s discuss how to short the cryptocurrency of your choice using different methods.

Direct Short Selling

When learning how to short cryptocurrency, this is the first method most people come across. Simply put, you borrow crypto from an exchange at a specific price and sell it.

Then, you wait for the price to go down. When it does, you buy the cryptocurrency back and return the borrowed cryptocurrency to the exchange. In this way, you earn the difference between the two prices.

Futures Markets

Like all other assets, some cryptocurrencies also have futures markets, in which you agree to buy a security in a contract. The contract specifies the price at which the security will be sold and the time when this will happen.

In buying a futures contract, you bet on the price of a security to rise. Doing this allows you to earn a profit on that security in the future. When you sell the futures contract, it indicates that you expect the price to decline in an upcoming bear market.

If you want to short Bitcoin futures, you can do so with Bybit Derivatives.

Contracts for Difference

These are one of the most popular ways to short cryptocurrency. With contracts for difference, brokers allow you to bet on a decrease or increase in an asset’s price without having to actually own the asset.

You just have to deposit a part of the margin account’s fund to guarantee that you’ll be able to buy the cryptocurrency at the particular price you’re betting on. The deposit remains in your possession, and the exchange or broker only holds it as collateral.

Thus, you only need to supply a certain fraction of the total trade amount to open your position. Because of this, you can amplify your return on investment (ROI) if the cryptocurrency moves in the direction you’ve bet on. However, this method obviously carries enormous risks if the currency’s price moves in the opposite direction to that of your prediction. Since you’re only putting in a sum of collateral that isn’t equal to the entire trade amount, your position might get liquidated when the price increases too much.

Cryptocurrency Put Options

With cryptocurrency put options, you can short a cryptocurrency without putting your investments at risk. If you’re able to deal with complex derivatives in a bear market, you can add buying cryptocurrency put options to your list of methods on how to short cryptos.

A put option gives the buyer the right to sell a cryptocurrency at a predefined price on a predetermined date. However, it should be noted that this is not an obligation, and is simply a right. Hence, users will have discretion as to whether they want to exercise the put option.

For instance, if you think that Bitcoin’s price will drop in the summer of 2023, you can buy a Bitcoin put for three months with a price of $20,000. If the price of Bitcoin declines below this strike price on the predetermined date, your put will earn you a trading profit.

On the other hand, if the price remains high, you won’t lose anything except the option premium, which is the fee you paid for holding the option.

Prediction Markets

If you want to learn how to short cryptocurrency while interacting with other investors, then consider prediction markets. These are similar to mainstream conventional markets.

As an investor, you can predict that a specific cryptocurrency will decrease by a particular percentage or margin. Then, someone else has to take you up on that bet. If the price really does go that way, you earn a profit. Some popular prediction markets include Polymarket and Augur.

Tips on How to Short Cryptocurrency

Since shorting cryptocurrency is based on several factors, you have to ensure you’re taking the right approach. After all, the last thing you’ll want is to short-sell cryptocurrency during a false retracement and end up taking a loss. The following are some tips to help you out.

Use Technical Analysis

Technical analysis refers to the use of real-world data to predict how the cryptocurrency market will behave in the future, which requires looking at the past performance of the currency you’re interested in, such as its movement and volume.

For instance, if you want to know how to short Bitcoin, you’d look at the trading volume of Bitcoin today in comparison to the past few months.

The crux of technical analysis is that history will repeat itself in terms of trends and pricing. This information is then used to make predictions about future price actions.

Moreover, technical analysis is based on the idea that any movement in the cryptocurrency market is not merely random, but is based instead on a trend, either short- or long-term. In most cases, if a cryptocurrency has followed a trend, it will eventually follow the opposing trend in due time.

Here are some indicators used in technical analysis to help with predicting price crashes and retracements:

• Average directional index (ADX) helps you determine how strong a trend is.

• Bollinger Bands® show whether the price of an asset is low or high on a relative basis.

• Standard deviation is applied to the annual rate of return on investment. It shows the historical validity of investments in a cryptocurrency.

• The relative strength index (RSI) indicates momentum in technical analysis. For any recent price change, this indicator determines the magnitude.

With these indicators, you can use trends to determine the opportunity for profits with an investment. You can also use some statistical tools, such as Fibonacci ratios and extensions, time-weighted average price (TWAP), volume-weighted average price (VWAP) and moving averages (MAs).

When you’re learning how to short Bitcoin or any other altcoin, you need to understand moving averages. In simple terms, moving average refers to the price of a cryptocurrency over a certain period. Typically, the moving average depends on the trading price of a coin in the past 20 days. To make your predictions more accurate, you can connect all of your moving averages.

However, all of these are complex statistical concepts that take some learning. If you’re a novice who’s still learning how to short Bitcoin and other currencies, you may be hesitant to get into advanced economics. Keep in mind that factoring in these indicators will allow you to make smarter investments.

Keep Up to Date With the News

Yes, we said “the news” — and not just the cryptocurrency news, since politico-economic events can send a market in any direction. Government crackdowns and regulations can lead to flash crashes in the cryptocurrency market.

If you suspect something like this is about to happen, you can capitalize on the situation by shorting cryptocurrency. However, make sure you’re not going against any government guidelines in the process, since that could land you in significant trouble.

Short Cryptocurrency During Rallies

Can you short cryptocurrency during sudden rallies? Yes. This is one of the best times to short any cryptocurrency. During these rallies, assets are overbought due to the fear of missing out (FOMO). After the hype dies down, the cryptocurrency comes back to its original value or declines, providing you with a chance to make profits.

Use Fundamental Analysis

Some experts might not believe cryptocurrency possesses any “fundamentals” at all, since its markets have such a short history. However, you can still use fundamental analysis (FA) to increase your chances of making wise investment decisions.

When doing so, uncover the forces that drive the supply and demand of the cryptocurrency you’re interested in. Some examples of relevant variables include market sentiment, news, trading, adoption and transaction activity.

With fundamental analysis, you study the intrinsic value of a cryptocurrency. You look at both external and internal factors to determine if an asset is undervalued or overvalued. Since cryptocurrency’s fundamental analysis isn’t the same as that of traditional markets, three different metrics are commonly used.

On-Chain Metrics

You can observe these metrics by looking at the data on a blockchain. In fact, you don’t have to do very much, since different websites have already generated this data. For instance, you can see data charts for different cryptocurrencies when Spot trading on Bybit.

Transaction Count

Transaction count also gives you a fair idea of the activity that takes place on a network. You can use moving averages and even plot a specific time period to determine how the activity surrounding an asset changes over time.

However, use this metric with caution. There’s no guarantee, for instance, as to whether a high transaction count is due to unique active addresses or the same people transferring funds between their different wallets, commonly known as wash trading.

Transaction Value

Transaction value tells you the accumulated value of funds transferred within a certain period. For instance, if ten people transfer Bitcoin in one day, the transaction count would be ten. If each Bitcoin were worth $40,000, the total transaction value for the day would be $400,000.

This data gives an overview of how much interest people are taking in a particular cryptocurrency as they engage in transactions involving it.

Where to Short-Sell Cryptocurrency

Now that you know what shorting cryptocurrency is about, it’s time to learn where to do it. Ideally, look for cryptocurrency exchanges that offer high trading volume for maximum liquidity. One place for you to start short-selling cryptocurrency is on Bybit.

To begin short-selling cryptocurrency on Bybit, first search for the BTC/USD trading pair interface and choose between Isolated Margin or Cross Margin. Then, click on Transfer to send your collateral to the exchange.

After that, start automatic borrowing and set up an auto-repay order. If the price drops, the amount you borrowed from the exchange will be repaid automatically. However, if it goes in the opposite direction, you need to repay the amount manually.

Final Words

In a nutshell, shorting cryptocurrency means selling it at a higher price because you expect its price to decline, due to fear in the market, or to retrace after a price rally. This lets you buy it back later at a lower price. Hopefully, with our handy guide, you now know what shorting crypto is all about, and where to do it legally. 

Keen on short-selling cryptocurrency on Bybit? Begin your short-selling journey by signing up with us and completing your account registration to get started.