How to Short Crypto: The Complete Guide

Estimated read time 11 min read

What is Short Selling Crypto and How Does it Work?

Short-selling cryptocurrency involves borrowing a crypto asset, selling it at the current market price, and repurchasing it later at a lower price to return it to the lender. Traders do this in order to profit from a decline in the coin’s price. It allows traders to capitalize on downward price moves.

When short selling, you open a margin trading account on an exchange, borrow the cryptocurrency you think will drop in value, and then immediately sell it at the current market price. If the price does indeed fall, you buy it back at the lower price to return to the lender and pocket the price difference as profit.

For example, if Bitcoin is trading at $20,000 and you think it will drop, you borrow 1 BTC, immediately sell it at $20,000, wait for the price to fall to $18,000, buy back 1 BTC, return it to the lender and keep the $2,000 as your profit.

Key Benefits of Shorting Crypto

There are several advantages of short-selling cryptocurrencies:

  • Profit from falling prices – Shorting lets traders make money when crypto prices decline, allowing profits in both rising and falling markets.
  • Effective hedging tool – Short positions can offset losses on other crypto investments during downturns. Shorting is an important hedging tool for crypto investors.
  • More opportunities – Being able to go both long and short creates more trading opportunities compared to only buying crypto assets.
  • Use leverage – Short selling platforms allow leverage trading to increase profit potential on accurate price drop predictions. However, leverage also amplifies losses.

Platforms and Markets That Allow Shorting Crypto

Several crypto exchanges and trading platforms now offer short-selling capabilities, including:

  • Binance – The world’s largest crypto exchange offers up to 5x leverage.
  • ByBit – Crypto derivative exchange providing high leverage up to 100x.
  • KuCoin – Margin trading platform enabling short positions with 5x leverage.
  • Kraken – Long-running exchange that has margin trading options with 5x leverage.

These are some of the most widely used platforms for shorting cryptocurrencies. They provide leverage, borrowing, and tools needed to execute short strategies.

Major Risks Associated With Short Selling Crypto

While shorting crypto can be highly profitable, there are also considerable risks:

  • Unlimited loss potential – Price could surge higher instead of dropping, leading to major losses without limit. Always use stop losses.
  • Margin calls – If a position falls and drops below maintenance margin requirements, a margin call will force the position to liquidate.
  • Volatility – Cryptocurrencies have very high volatility that makes timing short strategies difficult. Sudden rallies can create losses.
  • Borrowing costs – Fees and interest for borrowing the coins to short must be paid until the position is closed. This adds expense.
  • Forced closure – Exchanges can force positions to close at any time which could mean closing at an unfavorable price.

Managing risk is crucial when short-selling cryptocurrencies due to these hazards.

Managing Risks Through Stop Losses and Position Sizing

Risk management is vital when short-selling crypto because of the major loss potential. Here are key strategies to limit risk:

  • Stop loss orders – Set a pre-defined price at your position will close to contain potential losses if the price rises.
  • Position size – Don’t risk more capital than you can afford to lose. Only allocate a small % of your portfolio to each short position.
  • Risk/reward ratios – Evaluate if potential gains sufficiently outweigh potential risks before putting on a short trade. The upside should be greater than the downside risk.
  • Use leverage carefully – While more leverage increases possible gains, it can also amplify losses significantly without proper risk management.

Proper precautions are essential when shorting cryptocurrency. Implementing methods like stop losses and small position sizing compared to portfolio value protects capital even during volatile price swings.

Using Technical Analysis To Identify Reversal Signals

Technical analysis utilizes historical price and volume data to identify patterns signaling potential reversals. Classic reversal indicators help determine ideal entry points for short positions.

Oversold readings on the relative strength index (RSI) or a failure at lower highs on a double-top chart pattern indicate weakening momentum. These suggest good short-entry levels.

candlestick patterns like dark cloud covers and evening star formations also mark potential peak prices, flagging good areas to enter short trades targeting lower prices.

Applying technical analysis provides objective, quantifiable methods to time entries for shorting cryptos.

Tracking Social Sentiment for Signs of Weakness

Monitoring social media commentary and sentiment data from crypto communities can highlight the loss of positive traction for blockchain projects.

Declining chatter volume, increasingly negative tweet sentiment, and reduced Reddit/telegram users are Bearish social indicators of faltering momentum.

As optimism turns to complaints of missed promises, delays, and growing criticisms, coins become ripe short-sale candidates.

Fundamental Valuation Metrics To Spot Overvalued Coins

Evaluating key valuation metrics helps identify potentially overvalued cryptos to short:

  • Market Cap/Daily Transaction Value – High ratios indicate unreasonable valuations.
  • Price/Sales Ratios – Above 20 could signal excessive valuation detached from fundamental performance.
  • MVRV Ratio – Values over 3.5 often mark market cycle peaks.

Coins with clearly excessive valuations are likely to face heavy price corrections as markets reprice assets closer to intrinsic value.

Quantifying Developer Activity and Community Health

Blockchain projects rely heavily on developers to drive innovation. Metrics like GitHub commits, code improvements, and active developers indicate teams losing steam or gaining momentum.

Likewise, user bases, social following growth rates, and commercial partnerships show the general health of a crypto community over time.

Faltering development productivity or waning community enthusiasm preempts price declines as interest and investment capital fade.

Evaluating On-Chain Data For Distribution Red Flags

On-chain analytics provide visibility into the concentration of token distribution and selling activity:

  • Whale Concentration – Fewer, larger holders increase manipulation risks
  • Exchange Inflows – Rising inflows often preceeds increased selling pressure
  • Miner Outflows – Heightened miner distributions show waning confidence

Tracking on-chain movements identifies amplification of distribution risks, flagging short opportunities.

Careful evaluation across metrics combines to build high-conviction short sale scenarios before breakdowns occur.

What is Margin Trading and How Much Leverage is Wise?

Margin trading refers to borrowing funds from an exchange to increase buying power for larger positions. This power comes in the form of leverage.

Exchanges permit leverage from 2x up to as high as 100x when margin trading. However, leverage above 5x is extremely risky for most traders. 2-3x leverage provides ample risk/reward for shorting cryptos.

While added leverage magnifies potential gains, it also substantially increases risks of liquidation and heavy losses. Use leverage judiciously aligned with proven risk management rules.

Strategies to Identify Overbought Coins to Short

Analyze price bubbles, excessive valuations, and irrational exuberance to target shorts:

  • Compare Market Cap vs Transactions – High ratios expose hype outpacing reality.
  • Identify deviation above historical price averages – Significantly overextended from norms.
  • Evaluate accelerating price increases on rumors, not substance – Buy the hype bubble targets.
  • Review Technicals for signs of overheating RSI, MACD, etc. – Quantify overbought conditions.

Coins riding waves of speculation without true valuation support make ideal shorts once buying euphoria eventually reverts back to reality.

Executing Short Orders with Leverage and Managing Liquidations

When sufficiently confident in the downside target after analysis, execute short sell orders on margin for borrowed coins:

  • Enter a short position with 2-5x leverage only. Higher leverage entails liquidation risks
  • Set stop loss 5-10% above entry price to limit potential losses if trade goes awry
  • Size position at max 5% of account value, diversify with multiple non-correlated shorts
  • Monitor margin usage, and refill as needed to avoid liquidation. Monitor 24/7 in volatile markets
  • Book profits incrementally on the way down, re-shorting each bounce until a clear bottom established

Follow strict risk management rules to avoid ruinous liquidation calls. Plan exits by bottom fishing volatile moves not expecting perfect tops.

Taking Profits and Closing Margin Positions

  • Close positions incrementally taking partial profits where prudent
  • Book final profits once chart & indicators signal clear bottoming process underway
  • Close any remaining positions quickly if a stop loss is breached on a trade gone wrong
  • Repay borrowed assets and collateral plus interest to exchange to officially close
  • Withdraw as desired or maintain margin balance for additional short opportunities

Managing the exit right realizing gains while confirming true bottoms completes a short sell crypto trade profitably.

Short Selling vs Put Options for Betting on Price Declines

Short Selling Put Options
Borrow and sell assets for later repurchase No need to borrow an asset
Can lose more than invested capital Defines maximum loss risk
Typically less capital is required to open Requires premium payment upfront
Gains are unlimited to the downside Gains are capped based on the strike price

Both methods allow capitalizing on bearish price moves. Short selling offers greater profit potential but with higher risks. Options define risk/reward.

Options Order Types – Market, Limit, Stop-Limit etc

Major order types for options:

  • Market – Buy/sell immediately at current market prices
  • Limit – Set price ceiling/floor for entry/exit
  • Stop-Limit – Combine stop loss with limit for risk control

Use stop-limit orders to control risks when shorting options. Define maximum loss allowance while still capturing most upside potential.

Hedging Long Positions and Increasing Returns

Holding both long and short positions can hedge risks allowing increased exposure for higher returns:

  • Hedge spot purchases with short call options
  • Hedge HODL portfolio with index futures shorts
  • Pair shorts against unrelated asset classes with longs

The strategic pairing of risks delivers steady gains across diverse market conditions.

Futures Contracts vs Perpetual Swaps for Shorting

Futures Perpetual Swaps
Set expiration dates Remain open indefinitely
Must roll over contracts No rolling over required
Physically settled Cash settled with funding exchanges
Limited fixed supply Flexible readily available supply

Futures enable shorter term trades with expiry deadlines. Perpetuals allow riding sustained bearish momentum without time decay.

Risk Management When Using Crypto Derivatives

  • Start small testing strategies before increasing position sizes
  • Maintain account equity well above exchange liquidation margin ratios
  • Trade only reputable exchanges and understand contract specifications
  • Watch funding rates – high rates subtract value from shorts
  • Use stop losses and disciplined position sizing always

Cryptocurrency derivatives carry significant risks. Implementing basic risk management practices preserves trading capital over the long-term.

The Right Psychology for Short Selling

Understanding Drawdowns and Short Squeezes

Drawdowns represent temporary declines in equity before new highs. Crypto commonly drops 30-50% even in bull markets. Plan holding capacity or use stops.

Short squeezes occur when bearish traders are forced to cover positions fueling sharp but brief rallies against prevailing trend. Wait for reversion.

Keeping Position Sizes Small to Limit Losses

Limit position sizes to no more than 3-5% of portfolio value per trade. Smaller sizes allow riding through normal drawdowns and squeeze spikes without jeopardizing entire accounts. Set stop losses at 8-10% below short entry prices.

Avoiding Confirmation Bias and Overconfidence

Traders tend to seek information which confirms pre-existing outlooks. Actively question own assumptions and remain open to changing market conditions.

Success breeds complacency. Arrogance causes ignoring real risks. Stay humble, aware of limitations in analysis skills.

Handling Emotions When Positions Move Against You

Frustration builds when trades drop early. Anxiety compounds when drawdowns deepen. Fear sparks selling at the worst times.

Cultivate patience and composure when facing adverse moves. Stick to entry/exit plans rather than emotionally reacting. Think in probabilities over longer time frames.

Continuously Re-Evaluating Market Conditions

Analyze new on-chain developments, crowd emotions in forums, price action responses to news events that may alter original assumptions.

Be willing to change bias if emerging data conflicts with earlier conclusions. Divest deteriorating shorts early even for small losses to avoid larger impairments. Perspective changes preventing big hits enable long-term gains.

By acknowledging emotional and analytical biases, strategically limiting risk, and pragmatically reading the market – short selling becomes an asymmetric opportunity for profit during inevitable crypto bear trends.

Conclusion

As explored throughout this guide, short selling crypto assets presents a valuable opportunity to generate profits during bear markets. By borrowing overvalued coins, selling them, repurchasing at lower prices and returning them to the lender, traders capitalize on falling prices.

Executed judiciously with prudent risk management, shorting complements long only strategies – increasing opportunities in both advancing and declining market conditions. Technical and fundamental analysis combined with robust risk protocols allows experienced traders to thrive across cycles.

Of course, short selling does not come without hazards. The asymmetric risk profile, volatility and rapid price swings of crypto markets can lead to disastrous losses without proper precautions. Always use tight stop losses, constrained position sizing, and moderate leverage caps to contain downside.

Mastering the psychological aspects of short selling also proves critical. Checking confirmation biases, planning emotion regulation tactics for trade reactions, readily admitting inaccuracies in original hypotheses and modifying strategies accordingly accelerates progression along the learning curve.

Overall while adding complexity, crypto short selling unlocks vastly more choice in expressing market outlooks. The crypto ecosystem drastically expands with both bullish and bearish vehicles available to sophisticated traders. Just be sure to build skills systematically, act on logic not emotion, define risk parameters before entering any trade, and scale prudently over time.

Jack Dodd https://coinhatcher.com

Jack Dodd is a cryptocurrency enthusiast and investor who contributes regularly to CoinHatcher. He first became interested in digital assets in 2017 during the massive bull run that saw prices skyrocket.
Since then, he has actively researched and traded various cryptocurrencies while also studying blockchain technology and its potential to disrupt multiple industries. John is particularly fascinated by decentralized finance (DeFi) and the ways it can provide financial services to those without access to traditional banks.

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