Short position: how to profit from a market decline

Briefly about the main

Short position is not just a speculation on the decline of an asset's price. It is a risk management tool that allows experienced traders to protect their portfolio during bear markets and profit even when prices are falling. In stock markets and cryptocurrency exchanges, including all major trading platforms, short positions are used as a hedge strategy and a way to diversify income.

How the History of Short Selling Began

Short selling has existed on financial markets much longer than we think. The first mentions of it date back to the 17th century, when Dutch traders began selling shares they did not have in their portfolios, hoping for a further decline in prices.

The modern history of short selling includes high-profile cases:

• 2008 Financial Crisis: aggressive short selling forced regulators to impose temporary bans to prevent panic in the market.
• GameStop Event 2021: retail investors organized to rise up against large funds betting on the company's decline, artificially raising the stock price and causing a “short squeeze”

How a short position works and why it works

The essence is very simple: if you believe that the price of an asset will fall, you can profit from this prediction. Here is the mechanism:

Stage 1: Borrowing and Selling You provide the broker or exchange with collateral (margin), borrow an asset (stock, cryptocurrency, commodity) and immediately sell it at the current price. Now you have an open short position, and you pay a fee for using the borrowed funds.

Stage 2: Waiting for the Drop If the market meets your expectations and the price decreases — you make a profit.

Step 3: Closing the position You buy the same asset at a lower price, return it to the borrower, and pocket the difference as profit ( minus interest and fees ).

Practical examples of short positions

Example with Bitcoin

Suppose you are pessimistic about cryptocurrency. BTC is trading at a level of $100,000 per coin.

• You borrow 1 BTC and sell it for 100,000 dollars
• In a week, the price drops to 95,000 dollars.
• You are buying back 1 BTC for 95,000 dollars
• Returns the asset to the borrower
• Net profit: about 4,500-4,800 dollars (after deducting fees and commissions)

But if the price goes up to $105,000, the purchase will cost more than you expected, and holding the short position will result in a loss of $5,000+

Example with shares

The investor believes that the shares of XYZ Corp, which are trading at $50 each, are overvalued. He borrows 100 shares and sells them for $5000. If the price drops to $40, he closes the position by buying them back for $4000, resulting in a net profit of $1000. Conversely, if the price rises to $60, closing the position will cost $6000, resulting in a loss.

Where Short Positions Are Used

Short positions are available on virtually any serious financial market:

• Stock markets: a traditional area for short selling
• Commodity markets: short on gold, oil, agricultural products
• Forex: currency pairs
• Cryptocurrency exchanges: a relatively young but actively growing segment

Both retail traders and large institutions (hedge funds, institutional funds) regularly use short positions in their strategies.

Two Types of Short Sales: What to Pay Attention To

Covered short ( standard )

You borrow an asset from a broker or another trader before selling. This is a legal and widely used method. The broker or exchange guarantees the availability of the asset for borrowing.

Uncovered short (dangerous)

You are selling an asset without ensuring that it can be borrowed. This is practically prohibited everywhere due to the high risk of market manipulation and systemic risk. In some countries, it is even illegal.

What you need to know about margin requirements and risks

If you plan to open a short position through a margin or futures account, prepare for the following requirements:

Initial Margin In traditional markets, it is usually 50% of the value of the assets you sell. On cryptocurrency exchanges, it depends on the platform and leverage. For example: with 5x leverage, a position of $1000 requires only $200 in the account as collateral.

Supporting Margin The broker always monitors to ensure that you have enough funds to cover potential losses. If the margin level falls below the critical (usually 25%), the broker will issue a margin call requiring you to top up your account or close part of your positions.

Liquidation If you ignore the margin call, the broker forcibly closes your short position, often at the worst available price. This can end up costing significantly more than you expected.

When a short position is beneficial

Speculation on price decline

The most obvious reason: if you are confident that the price will fall, shorting allows you to profit from that prediction.

Portfolio Hedging

You have long positions in the stocks of a certain company or index, but are concerned about a short-term decline. Opening a small short position in a related asset helps to offset potential losses.

Detection of overvalued assets

Professional investors often bet that overvalued companies or projects will eventually revert to their true value. A short position allows them to profit from this correction.

Main risks to avoid

Endless losses

Unlike a long position, where the maximum loss is the value of your investments, a short position theoretically has unlimited losses. If the price continues to rise, you could lose much more than you invested.

Short squeeze

When buying activity suddenly increases (often provoked by positive news), the price rises sharply. Traders holding short positions panic and close them at any cost, exacerbating the decline even further.

Borrowing costs

Commissions and interest for using borrowed funds can be significant, especially for high-demand borrowing assets.

Dividend Payments

In the stock market, short sellers must pay dividends that are distributed during the holding of the position, which adds to the costs.

Regulatory restrictions

During market crises, regulators may impose temporary bans on short selling, forcing you to close positions without any room for maneuver.

Controversies Surrounding Short Positions

Short selling remains a debated topic. Critics argue that it can exacerbate panic during crashes and unfairly harm legitimate companies and their employees. However, defenders point out that short positions expose fraudulent schemes and overvalued assets, increasing overall market transparency.

Regulators have found a compromise:

• Raising Rule: short sales are allowed only when the price increases ( that is, when the price has just risen )
• Disclosure of large positions: investors are required to report significant short positions
• Restrictions on Naked Shorts: in the USA, the SEC prohibits naked short selling due to regulation SHO

Conclusion

A short position is a powerful tool that allows traders and investors to profit in falling markets and protect their portfolios. However, it requires discipline, an understanding of risks, and careful planning.

Regardless of whether you are using a short position for speculation or hedging, remember the potential for unlimited losses, borrowing costs, and the risk of sudden market movements. Success depends not on audacity, but on proper risk management and calculated bets on trends that you clearly understand.

In cryptocurrency and traditional markets, short positions remain a reliable part of the trading arsenal for those ready for potential challenges.