Short selling is a technique of selling a commodity at a high price with the hope of being able to buy it back and return the money when the commodity price drops. Several overseas Bitcoin trading platforms have implemented this short-selling function.
Traders can use short selling as speculation, and investors or portfolio managers can use it as a hedge against the downside risk of long positions in the same or related assets. Speculation carries the possibility of great risk and is an advanced trading method. Hedging is a more common transaction that involves placing an offset position to reduce risk exposure.
In short selling, a position is opened by borrowing a crypto asset such as bitcoin or another asset that the investor believes will decrease in value. The investor then sells these loan assets to a buyer who is willing to pay the market price. Before a borrowed asset has to be returned, traders bet that the price will continue to fall and they can buy it at a lower cost. The risk of loss on a short sale is theoretically unlimited as the price of any asset can rise to infinity.
Why short selling?
The most common reasons for short selling are speculation and hedging. A speculator makes a pure price bet that it will decline in the future. If they are wrong, they will have to buy back the stock higher, at a loss. Because of the added risk in short selling due to the use of margin, it is usually done over a smaller timeframe and thus is more likely to be an activity undertaken for speculation.
One can also sell short to protect a long position. For example, if you have a call option (which is a long position), you may want to short the position to lock in profits. Or, if you want to limit downside losses without actually getting out of a long position, you can sell short in closely related or highly correlated stocks.