Shorts and longs refer to sell and buy positions in trading that are commonly used for margin trading with leverage. In cryptocurrency trading, where assets are highly volatile, traders can use these positions to profit from price fluctuations. It’s important to note that hedging is also crucial when trading in long and short positions, which involves taking certain measures to protect against situations where the market moves in the opposite direction of open positions.
The history behind the terms “short” and “long” positions
The terms “shorts” and “longs” have their origins in medieval Europe, where stick-tags made from hazel were used to record debts. The tags had transverse notches on one of the faces to indicate the amount put into circulation. The tag was then split along the notches, leaving a long part with a handle and a short part. The two parts were kept by the two parties involved in the transaction and were used to prevent forgery. This practice is believed to have given rise to the terms “stock market” and “long” and “short” positions.
The expressions “short” and “long” became common on American stock and commodity exchanges in the 1850s, and they have since migrated to the world of cryptocurrency trading.In the 1850s, the expressions “short” and “long” became prevalent on the American stock and commodity exchanges. The earliest known reference to these terms may be in The Merchant’s Magazine and Commercial Review, Vol. XXVI, from January-June 1852. Despite their names, short positions can be held for a significant period, such as a week or a month, while long positions can be relatively brief. These terms have now migrated from traditional finance to the bitcoin industry.
A long position is the purchase of an asset with the expectation of its price increasing, with profits depending on the rise in asset value. This type of transaction is popular with retail investors and commonly used in the spot market.
Short positions involve the sale of a financial instrument in anticipation of its price falling. However, the mechanics of a short position are more complicated than a long position. Traders borrow an asset and sell it on the open market at its current price, then wait for the price to drop to buy back the borrowed asset at a lower rate and repay the debt with interest. The profit comes from the price difference. If the asset price rises, the investor experiences a loss.
For example, in December 2017, a trader bought bitcoins for $19,000 per coin and sold them in the same period for $19,000. In February 2018, when the price significantly dropped, the trader bought back the same amount of bitcoins and paid the lender approximately $6,000 for each BTC. The trader earned a profit of $13,000 from each coin.
The “Bulls” and “Bears”
Bulls and bears are terms used to describe exchange players based on their trading strategy. Bulls refer to those who open long positions, while bears refer to players who place short positions in anticipation of a market decline. However, traders often employ both strategies simultaneously, and the volume of their positions may vary.
Margin trading allows for the opening of short positions, which is not possible in the spot market of cryptocurrencies, where only long positions can be traded. To engage in margin trading, a user must provide a pledge or deposit an amount (margin) that will ensure the payment of debt obligations according to the rules of the exchange.
The concept of margin is closely related to leverage, which is a multiplier that increases the user’s leveraged deposit available for trading. In the cryptocurrency market, this ratio can range from 2:1 to 100:1 or more. For example, trading with 50x leverage means that a deposit of $100 can open positions up to $5,000.
If the market value of the cryptocurrency moves in the expected direction, the income increases in proportion to the chosen leverage. Upon closing such a position, the collateral is returned to the lender along with commission fees, and the remaining profit is credited to the user’s account.
However, if the price moves in the opposite direction, and the value of the assets of the trader reaches the amount of the loan with interest, the exchange will automatically liquidate all the player’s positions and return their funds to the lender. Margin is fully included in the amount returned to the lender.
In classic trading with leverage in the stock market, a margin call is often required, which is the moment of liquidation. However, in margin trading of cryptocurrencies, the exchange will automatically liquidate all positions once the value of the assets of the trader reaches the amount of the loan with interest.
Traders can also manually close their position and limit trading risks by placing a “stop loss” order, which automatically closes a transaction when a certain price is reached. If a trader completes an unsuccessful transaction on their own, they will only lose part of the margin, not the entire position.
The strategy of hedging is commonly used in the cryptocurrency market to mitigate risk in case the price trend of an asset goes against the trader’s position.
If a trader has an open long position and the cryptocurrency price drops, they can use hedging to balance their long position by opening short positions. This allows the trader to remain “at zero” in the event of an unfavorable change in the market.
Hedging can be accomplished by leaving the original long position as is and opening a short position or by utilizing additional opportunities. Position hedging is typically used for medium- and long-term strategies and is different from intraday trading, which relies heavily on market speculation.
Futures contracts, such as perpetual and futures, are a popular tool for hedging positions. Perpetual contracts involve paying a funding rate every eight hours, which is paid by traders 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. Options, which are derivative financial instruments for more advanced market participants, can also be used for hedging.
In the averaging strategy, an investor gradually purchases an asset at decreasing prices, which helps to lower the average purchase price.
For instance, if the price of bitcoin initially reached $2900, and then started declining, a trader might buy coins at successive levels of decline such as $2800, $2600, $2400, $2200, and $2000. In this case, the average purchase price would be $2400. Later, if the price of bitcoin rises and returns to the level of $2900, the investor stands to make a profit.
When it comes to the pros and cons of long and short positions, opening long positions is generally a more straightforward strategy, based on the principle of buying low and selling high. In contrast, shorting can be a more complex and riskier investment strategy that requires a comprehensive analysis of market dynamics. It may be more suitable for experienced traders, and even then it should be done with caution.