What happens when investors take short or long positions on Bitcoin?
You may have heard analysts attributing sudden spikes in the price of Bitcoin to a short squeeze, but what exactly is taking a short or long position, and how can it affect the price of Bitcoin and other assets?
The long and short of it
To take a short or long position means an investor is either expecting the price of Bitcoin to go up or down. To be short Bitcoin, investors are counting on the price going down, and to be long Bitcoin, the investor is expecting the price to go up.
In other words
Long position = Bullish
Short position = Bearish
How do investors take these positions for or against Bitcoin?
Long trading is investing in Bitcoin with the expectation of the price going up, and possibly selling it in future at a higher price than what you bought it for.
Shorting is more complicated. When shorting Bitcoin, a trader borrows Bitcoin from an exchange that offers this service and sells it at current prices. By doing this, they are short of what they borrowed, hence it being called taking a short position. At some point, the trader has to return the borrowed funds.
Betting that the price will drop below the price they sold it for, traders wait for a drawdown and buy the Bitcoin back at a lower price. By doing this, they can return the Bitcoin to the exchange and pocket the difference between the initial selling price and the lower buying price.
What does this look like in practice?
For argument’s sake, let’s say one Bitcoin is worth $100.
If an investor wants to short Bitcoin for $1,000, they borrow 10 BTC from an exchange (10 x $100), and sell the lot at a current price of $1,000. Investors will refer to this position as being short 10 Bitcoin.
Say the BTC price drops all the way down to $50, half of what it was when the investor sold the borrowed BTC.
The investor then buys back 10 BTC at $500 (10 x $50) and returns the borrowed 10 BTC to the exchange, pocketing the difference of $500.
Using margin trading, investors often magnify these trades with borrowed money.
What is margin trading?
Margin trading allows investors to increase their positions manifold by borrowing money from exchanges that offer leverage.
Using leverage, an investor can turn a $100 short or long position into a $2,000 position, for example. This type of trading comes with very, very serious risk and many traders have lost all their money and then some on leveraged trading.
How does this affect my Bitcoin?
Professional investors generally have a margin trading account at a futures exchange, which is not all that different from a credit account at a bank. Similar to a credit account, there must be enough money in the account to cover fees and other running costs. In other words, the investor’s account must generally be in a healthy position and not pose a risk to the creditor.
If the price of Bitcoin drops suddenly, investors in a long position are paid a call by the exchange demanding that the investor sell out of their position or refinance the account. This is the infamous margin call, which forces investors to sell their Bitcoin to cover costs, otherwise known as liquidating their positions. If many investors do this at the same time, it can cause the price of Bitcoin to drop.
On the other hand, if the price of Bitcoin unexpectedly goes up, investors in short positions are often forced to buy back the borrowed Bitcoin at a higher cost. This “short squeeze” often results in sudden spikes in the price of Bitcoin due to heightened buying pressure, more demand, pushing up the price.