What are short and long positions and how to use them in cryptocurrency trading?

Main

• Shorts and longs are short and long positions (sell and buy) in trading. They are mainly used for margin trading, that is, trading with leverage.
• Most cryptocurrency assets are characterized by high volatility. The use of shorts and longs allows traders to make a profit in the process of price fluctuations.
• When trading in long and short positions, you should remember about hedging – certain actions aimed at protecting against situations when the market moves in the opposite direction to open positions.

Origin of Shorts and Longs

In medieval Europe, stick-tags or counting sticks made from hazel were used to record debts. On one of the faces of the tag, transverse notches indicated the amount put into circulation, after which the tag was split along the notches, but not completely, but with a cut in the “handle” area. The result was a long part with a handle (stock) and a short part (foil), complementing this long part to a full stick. Notches were on both parts. By coincidence of these parts, control was carried out. It was believed that because of the texture of the hazel, forgery was impossible. The two parts stored the two parties involved in the transaction. From this practice, the terms “stock market” (stock market), as well as “long” (long) and “short” (short) allegedly arose.

The expressions “short” and “long” became common on the American stock and commodity exchanges in the 1850s. Possibly the earliest reference to short and long positions present in The Merchant’s Magazine, and Commercial Review, Vol. XXVI, for January-June 1852.

Despite the names, the period for a short position can be quite long (a week, a month), while the period for a long position can be quite short. From the world of traditional finance, the terms short and long have migrated to the bitcoin industry.

Who are the “bulls” and “bears”

Exchange players are usually called bulls or bears, depending on what strategy they follow. Bulls (that is, those who open longs) are called “bulls”, and players who place short positions, that is, put on a fall in the market, are called “bears”.

These terms are arbitrary: there are no pure bulls and bears in the crypto market, often the same trader trades both short and long at the same time, although the volume of positions may differ.

What is long

Long (long position) – buying an asset in the expectation that it will rise in price. The amount of profit depends on the increase in the value of the asset. A long position is the most popular type of trade with retail investors and is used in the spot market.

What is a short

Short in simple terms is the sale of a financial instrument in the expectation that it will fall in price.

However, the mechanics of a short position are somewhat more complicated than a long position. Under this scheme, a trader borrows an asset and sells it on the open market at the current price. Then he waits for the rate to fall, buys the amount of the asset that he borrowed at a lower rate and repays the debt with interest. The trader keeps the profit received due to price changes. Otherwise, if the price of the asset rises, the investor will receive a loss.

Example

In December 2017, a trader purchased bitcoins at $19,000 per coin. He sold those coins in the same period for $19,000 and then paid the lender approximately $6,000 for each BTC when the price dropped significantly in February 2018. From each coin, he made a profit of $13,000.

What is margin trading?

If in the spot market of cryptocurrencies it is possible, in fact, to trade only long positions (although there are tricks that are logically similar to shorting), then in margin trading it becomes possible to fully open short positions.

As part of margin trading, which provides the opportunity to make deals with leverage, the user must provide a pledge – deposit an amount (margin) that guarantees the payment of debt obligations according to the rules established by the exchange.

The concept of margin is closely related to the concept of leverage or leverage, a multiplier that increases the user’s leveraged deposit available for a trade. In the cryptocurrency market, this ratio can range from 2:1 to 100:1 or more. That is, trading with 50x leverage means that when you deposit $100 in cash, you can open positions up to $5,000.

If the market value of the cryptocurrency moves in the direction expected by the trader, the income increases in proportion to the chosen leverage. At the time of closing such a position, the body of the collateral is returned to the lender along with commission fees, and the rest of the profit received is credited to the user’s account.

What is hedging?

The cryptocurrency market uses a mechanism known as hedging – “insurance” in case the trend in the price of an asset does not match the position of the trader. For example, you have a long position open and the price of a cryptocurrency is going down.

Hedging is based on the opening of short positions, which balance long positions and allow you to stay “at zero” in case of an undesirable change in the market situation. The investor leaves the original long position intact and opens short, or uses additional opportunities.

Position hedging is a solution for medium- and long-term strategies. This mechanism is somewhat contrary to intraday trading, where market speculation prevails. A popular way to hedge positions involves the use of futures contracts: perpetual and futures.

Perpetual contracts work according to the following principle: every eight hours, a so-called funding rate is set. The latter is paid by the participants in the transactions to each other instead of transferring the contracts themselves or their full value. Depending on the market situation, either the holders of long contracts pay the holders of shorts, or vice versa.

Futures contracts are executed automatically if the investor does not close them before the expiration day. You can hedge not only with futures, but also with options – derivative financial instruments for more advanced market participants.

What is averaging?

As part of this strategy, the investor buys the asset at an increasingly lower price, thereby lowering the average purchase price.

Pros and cons of longs and shorts

Opening long positions is a more understandable strategy for a beginner, which boils down to the simple principle of “buy low, sell high.”

Shorting can be an effective investment strategy, but is much more risky than long-term investment or averaging. Only experienced traders who are able to comprehensively analyze market dynamics should open short positions for large amounts.