Traders do not want to sit on the sidelines, although there is nothing wrong with it for a beginner during a downtrend. It is easy to understand that being invested during a confirmed uptrend will make a trader some profits. We call that position being long. Simple to understand and it feels great while price action is cooperating.
How about when the market turns and goes down, either as a temporary correction or a severe trend reversal? Traders can make profits even then by selling short on exchanges that offer margin accounts (Kraken, Bitmex, etc.). Let’s explain a little.
Short selling is motivated by the belief that a security’s price will decline. The trader borrows the security from a broker and sells it, believing that he or she can buy the security later at a lower price in order to return it at a profit.
Short selling is a common practice in financial asset markets, including crypto. Short selling typically requires a margin account and, IMHO, should only be attempted by experienced traders who are familiar with the additional intricacies and greater risks.
Here is an example of how shorting works in the stock markets: A trader believes that stock XYZ, which is trading at $100, will decline in price. S/he therefore borrows 100 shares in the market and sells them. The trader is now “short” 100 shares of XYZ, since s/he has sold something that s/he did not own in the first place. The short sale was only made possible by borrowing the shares, which the owner may demand back at some point.
Sure enough, XYZ stock falls to $75 over the next week or month. The trader decides to close the short position and buys 100 shares of XYZ at $75 on the open market to replace the borrowed shares. The trader’s profit on the short sale – excluding commissions and interest on the margin account – is therefore $2500.
Why bother to understand short selling when it is not a recommended tactic for beginners?
Because price action is affected a great deal by short sellers as there is more than plenty of short selling in the cryptocurrency markets. As a beginner, I believe that it is smart to first learn trading long and gaining a lot of experience. You will be running into short sellers sooner than later in the market.
Understanding the mentality of a short seller, the mechanics of short selling, and what liquidity zones are will help anyone become a more successful trend, momentum or swing trader.
What to use margin exchanges for – and what to avoid
I see many people on all kinds of social media platforms use margin exchanges in a way that I’d call gambling. Margin platforms can be an insanely valuable tool to use to further your trading. They can also leave you with big losses and a burnt account.
That’s why I’ve decided to write an article about how to utilize them effectively instead of just blindly charging in.
Use case #1 – Protecting the value of your spot exposure
Let’s say you own 1 BTC in cold storage locked away that you’d like to keep for the long-term but you feel like BTC is going to take a nose dive short-term and would like to reduce your exposure to it.
You could either:
Sell your Bitcoin by:
Connecting to your wallet
Sending the BTC to an exchange
Selling it to USD
Withdraw that USD
Wait for better times
Rebuy the BTC
Send it to your wallet
or you could:
Sell the equivalent of your spot BTC on a margin trading platform by:
Sending 0.33 BTC to the platform
Short 1 BTC by using x3 leverage (Borrowing from the broker)
This way you keep your cold storage, avoid all the transaction hassle while still essentially being in USD (Equal short and long position). BTC goes down? Your margin account grows while your cold storage value decreases. BTC goes up? Your margin account shrinks while your cold storage value goes up. You avoid most of the work while still being in the same position. The only thing you need to worry about is fees and those can actually benefit you if you do it right. I’ll write a short article on how to correctly avoid fees (or how to get paid for holding a position) later.
Use case #2 – Protecting your alts from BTC downmoves
Let’s say you’re bullish altcoins while being bearish on BTC.
You can short BTC on the margin trading platform while keeping your alt in the market. This is what I did in December last year. I was pretty bearish on BTC and bullish on some of my alts. I put 1/3rd of my entire portfolio on Bitfinex and shorted BTC with it while keeping my altcoin portfolio.
BTC crashed while alts mooned, I made money on both sides of the trade.
What would’ve happened if I was wrong?
I would’ve lost money. This strategy is only ever applicable during alt seasons.
You need the ratios to pump while BTC is retracing, that only happens at the tail end of an altcoin market. If you’re wrong and alts go down you lose money, if you’re right and alts go up you make money. You can also do this when BTC is ultra bullish. Margin long your altcoin exposure away. (Dangerous, if the market turns you get rekt twice as hard and only ever makes sense right before an alt season)
Use case #3 – Protecting yourself against counter party risk
If you want to trade but you don’t trust exchanges with your money margin platforms can be an excellent tool to use. If you’re trading one third of your crypto allocation on x3 on a margin exchange the amount you risk, should the exchange go under/exit scam, is only a third of what it would be if you traded your spot on it.
Use case #4 – As an experienced professional trader
If you know what you’re doing margin trading can be insanely profitable.
Unlike most people think, however, the professionals trading on these margin platforms rarely (if ever) use leverage to increase their position size significantly. “What kind of leverage do you use” is generally not the right question to ask. If you have 1% of your portfolio on Mex for example, using 10x leverage isn’t as crazy as when you’ve got 100% of your portfolio on there. Position size and % risk of portfolio is far more important. That said, I don’t think I know anyone trading big size successfully that goes above x3 leverage regularly.
Every professional trading on platforms that allow margin trading use strict risk management and position size rules. At least the ones that don’t end up blowing out their accounts.
No risk management = Rekt over the long run, no matter how good you are.
Don’t be an idiot and chase the big money, go at it slowly and do it the right way.
What not to use margin trading platforms for
Idiot use case #1 – Increasing your position size so you can make more money
Let’s say Pete owns 1 BTC and feels like selling and buying that 1 BTC grows his account too slowly so he transfers it to a margin exchange to trade with 10 BTC while disregarding risk management.
Pete is officially an idiot. A sane trader usually risks ~2% of his balance on a given trade. That means Pete would stop out of his 10BTC trade after only a 0,2% move or completely disregard risk management. It’s easy to see why Pete is a moron.
Don’t be Pete.
Idiot use case #2 – You lost money on altcoins and are trying to make it back with margin trading
Margin trading is not only substantially harder than trading shitcoins, you’re also revenge trading. One of the easiest and quickest ways to lose all your money. If your risk management, your trading strategy & plan aren’t perfect, don’t even try to start margin trading, you’ll either get stopped out again again or just end up liquidated. If you want to dip your toes into margin trading transfer a low amount ($10–$100) to BitMex / Deribit / Bitfinex and trade those for a month.
Once you’re consistently able to grow that, increase your balance.
Idiot use case #3 – Everyone else does it, so it must be cool
Don’t even get me started.
Crypto is already volatile enough, there is no need for most people to start leveraged trading in the first place other than hedging. I’ve seen too many people lose all their money doing so. Don’t be an idiot, stick to small position sizes until you’re comfortable and your trading plan works and then slowly increase your size. No need to blow your account.
There are several ways to effectively (or not effectively) use margin trading platforms but these are the most important. If you’re interested in trading on one, always make sure your risk management is on point.
People like Pete die in markets like these.