What are long and short positions in crypto trading?
What is a position in crypto trading?
Before explaining long and short positions in crypto trading, it is essential to understand what a position is. Either we are talking about stock or cryptocurrency trading, a position has the same meaning.
A position refers to a statement of a market commitment held by a trader who can gain or lose profits. The term relates to the notion of an investor believing stock or cryptocurrency prices will go up or down.
Positions are defined by size and direction. In other words, a trader’s position can change based on the amount of assets owned and whether these assets are being purchased or sold.
If you want to engage in trading activities, it is important to determine your position; without knowing which position to take, you might not be able to gain profits from market fluctuations or even face additional losses.
Basics of long and short position trading
Before we get down to long and short crypto trading explanations and strategies, it is significant to highlight the key trends that drive the crypto market. Being a crypto trader means that you are buying and selling cryptocurrencies such as Bitcoin and Ethereum to gain profit from market fluctuations. Understanding the principles behind long vs. short trading is imperative for every potential trader.
Unlike traditional stock markets, the cryptocurrency market is open 24/7 which provides more possibilities but also brings to the table several challenges such as its volatile and unpredictable nature. In simple terms, prices tend to notably increase or decrease over short periods.
Volatility is triggered by numerous factors such as regulatory news, global and other significant market events, technological innovation, and market sentiment.
For example, the EU's MiCA legislation shook the crypto landscape. To find out more, check out this article: 'What is Markets in Crypto Assets (MiCA)? Europe's Crypto Law'.
Potential crypto traders and investors need to understand the crypto market’s supply and demand dynamics. For example, scarcity can lead to price surges while oversupply can cause a downtrend. If you aim to capitalise on market movements, it is essential to understand these dynamics concerning desired cryptocurrencies.
Crypto trading fundamentally depends on the current market trends and movements; keep in mind that crypto trading requires not only an understanding of these dynamics but also a substantial degree of technical knowledge to recognise the cryptocurrencies' value proposition.
What is the concept of long and short positions?
Long and short positions refer to opposite strategies used by traders and investors to speculate on the price movements of respective cryptocurrencies.
For example, to profit from a cryptocurrency’s price increase, a long position refers to purchasing it with the expectation that its value will rise over time. On the other hand, going short means selling a crypto asset you don't own in anticipation of a price reduction, then buying it back at a lower price to close out the position and profit from the price drop.
Therefore, these strategies are frequently used by crypto investors and traders to navigate the highly volatile crypto market and spot opportunities in both bullish market sentiment and bearish market conditions.
The crypto community uses the terms 'bull' and 'bear' frequently. To learn more about these aspects of market sentiment, why not read this article: 'What do the terms Bull & Bear Market mean?'.
What is a long position in crypto trading?
The crypto community simply refers to it as ‘going long’. This position is based on a positive notion of the crypto market's future performance, such as growth and value appreciation of respective cryptocurrencies. It presents a cornerstone of traditional investment strategies adapted to the conditions of the cryptocurrency market.
Crypto traders take long positions when they buy a cryptocurrency at a particular price to sell it at a higher price in the future. The difference between the purchase and the selling prices is the profit.
For example, you have conducted a thorough market analysis and you think that Bitcoin's price will go up. You buy, for instance, 2 BTC at a current market price of $50,000 each. This means that you are ‘going long’ on 2 BTC. If Bitcoin’s price doubles over time, it means that you get a 100% increase in the value of your BTC.
Risk associated with long positions in crypto trading
Since the nature of any market is featured by a rise over time, long positions tend to be generally less risky than short positions. Since the volatile crypto market, long-term investments can also be subjected to substantial price movements.
Long position trading requires a careful market analysis and the assessment of several different factors such as regulatory changes, technological innovations, and broader economic events as well as the need to implement risk management strategies.
What is a short position in crypto trading?
Short positions indicate that a crypto investor or trader thinks that the price of a cryptocurrency will decrease in the future and aims to profit from that decrease. The most common short position technique is called short selling which refers to a strategy when you sell crypto you don’t own and plan to buy them back at lower prices.
Therefore, selling short involves borrowing a cryptocurrency and selling it at the current market price; the trader then buys it back at a lower price, returns the borrowed coins, and keeps the difference as a profit.
For example, if you want to sell short Bitcoin, you need to borrow it from a broker. You decide to borrow Bitcoins for $40,000 per coin and short-sell it for $80,000; this leaves you with 2 BTC to short. Once you sell BTC, the price drops to $30,000 per coin. Now you buy those 2 BTC for a total of $60,000 which means you made a profit of $20,000.
Keep in mind that short positions are more complicated for beginners than long positions. Investors tend to make informed decisions as they don’t just buy or sell assets without careful projections.
In the context of cryptocurrency market trends, a short position is not just a defensive strategy to hedge against potential losses but a proactive approach to profit from market downturns as well.
Risks associated with short positions in crypto trading
The main benefit of short positions refers to the chance to gain profits from a price drop. If a trader accurately recognises a bearish market perspective and shorts a certain cryptocurrency, they might purchase it at a lower price and keep the profit as the difference.
On the other hand, short positions generally carry potentially unlimited risk; therefore, traders with a lower risk tolerance may prefer engaging with the long position strategy. The potential profit in a short position is limited to the initial value of a cryptocurrency, but the potential loss is theoretically unlimited. If the price rises significantly, short sellers can face substantial losses.
Short positions require the implementation of effective risk management strategies, exact timing, and thorough market monitoring to successfully navigate the volatile cryptocurrency market.
What does it mean to cover shorts?
Covering shorts is a concept familiar to short sellers; it refers to the process of buying back borrowed coins to close out a short position.
Generally, when traders think that the price of a particular crypto asset will no longer continue to decrease or they decide to cut losses faced by unpredicted market movements, they tend to cover shorts.
Covering shorts means that the initial transaction is being reversed. Crypto traders buy the same amount of coins they borrowed and sold, typically at a lower price than they sold it for. Covering shorts concludes the short selling cycle.
Potential tax implications of long and short positions
Profit gains from long positions are in most jurisdictions regarded as capital gains. When you sell your assets, capital gain taxes may apply.
On the other hand, short positions may sometimes bring to the table certain tax uncertainties and difficulties. In some jurisdictions, the activity of borrowing and selling a crypto asset short may not result immediately in a tax obligation since a short position is not closed until the borrowed asset is bought back. Therefore, you might experience capital gains or profit losses when closing out a short position.
Keep in mind that crypto tax laws differ from one country to another; you need to be aware of applicable tax laws in your jurisdiction to maintain compliance and make informed decisions.
Long or short strategies?
The decision to take a long position or short position in crypto trading mainly depends on the trader’s market outlook. While a long position is taken with a bullish outlook in mind, short positions are based on the notion of price decreases.
The trader’s level of risk tolerance needs to be taken into account as well. Long positions encompass a maximum loss limit as the crypto asset can only drop to zero, but short positions carry potentially unlimited risk as there is no cap on how a coin’s price may go up.
The choice between long and short positions also depends on the trader's investment timeframe since long positions are commonly associated with a long-term outlook, while short positions are suited for short-term trading activities.
Traders have to analyse market trends and potential future advancements. Additionally, the long vs short position proportion in the market offers insights into the market sentiments as they can significantly impact market liquidity and price movements; for example, if short positions are dominating, the market sentiment might be bearish, while a widespread presence of long positions indicates a bullish market.
To become a crypto trader who engages in either long-term or short-term trading strategies, it is imperative to keep learning. Check out our Learn Crypto Academy to stay on your toes.