What is Short Selling?
Aside from simply buying and selling bitcoin as a reflection of which way they think the market will go, traders can take ‘long’ or ‘short’ positions. This means they are borrowing funds to buy or sell bitcoins, generally from other traders (rather than the exchange itself). If the trade goes their way, they settle up the original amount with the lender (plus interest) and pocket the difference as profit. If not, they have to pay from funds they make available for that eventuality.
This article is for information only. Bitcoin Bulletin will never give you trading or investment advice.
By borrowing large amounts of funds, traders can multiply their profits – and losses – far more quickly than they would by simply buying or selling bitcoins. Trading ‘on margin’ like this is risky, for obvious reasons – it’s very easy to get wiped out completely. What’s even more riskier is if you do it naked – and we don’t mean without clothes on! Naked Short Selling is where traders don’t actually borrow the assets to make their trades, so they are not backed by any collateral. Incidentally early crypto adopter and owner of Overstock.com, Patrick Byrne, has been a vocal critic of this practice in the past.
Predicting market sentiment
You will sometimes read about the level of shorts in the market, or the ratio of longs to shorts. This is a measure of the total amount of money that is betting the price will rise (long) or fall (short). It can be worth watching for a couple of reasons.
Firstly, the amount of money that is short indicates overall market sentiment. High shorts means a lot of traders are betting against the market or actually selling bitcoin because they think it will fall. Often, the amount of shorts indicates a fall is to come for that reason; high shorts can coincide with a significant price drop. If you’re using this as an indicator for market sentiment, you should also consider the ratio of longs to shorts – that is, the total amount of money betting on price rises/falls.
However, it should also be said that in certain market conditions, where the trend isn’t clear and trading volumes are low, a rise in longs or shorts can be exploited by whales, who push the market in the opposite direction, profiting as these traders are liquidated (forced to settle), driving the price further in the whale’s favour. The market has a way of making fools of as many people as possible, and the whales love to help it.
Finally, if you haven’t seen The Big Short, then you should watch it immediately. That is all.