A long/short investment strategy is usually associated with hedge funds, but a growing number of cryptocurrency owners are using the same approach to diversify their portfolio and increase their profits.
If you like the idea of making money when cryptocurrency prices go up and down, then this is a strategy you want to pay attention to.
In this guide, we’ll be showing you how to long/short cryptocurrencies and what this can bring to your investment strategy.
By the time you’ve finished reading this, you’ll know the following:
- What is a long/short investment strategy?
- Why should I long/short cryptocurrencies?
- How to long cryptocurrencies
- How to short cryptocurrencies
- What makes a good long/short strategy?
- How do I get started?
First, let’s start by explaining what a long/short strategy is in simple terms.
What Is a Long/Short Investment Strategy?
The easiest way to explain a long/short investment strategy is to define what we mean by “long” and “short”.
When you take a long position on an asset, you’re buying it outright, which means you own the stock itself and your profit relies on it increasing in value.
As a crypto investor, this is the equivalent of buying Bitcoin or other digital currencies on an open market when you expect prices to increase over a reasonable period.
In the case of a short position, you’re essentially borrowing an asset with the expectation that its value will decline.
The aim is to sell at a high price and then pay back your lender at a lower rate when values drop, by which time you’ve pocketed the difference for yourself.
So, let’s say you bought a bunch of Bitcoin at around $19,000 per coin in November last year.
You could have sold those coins for $19k at the time and then paid back your lender roughly $6k per coin when prices were at their lowest in February 2018 – making a tidy $13,000 profit on every coin.
A long/short strategy is when you combine these two investment methods to take long positions on assets you expect to increase in value and short positions on those expected to drop while making a profit on both outcomes.
Why Should I Long/Short Cryptocurrencies?
The cryptocurrency market is one of the most volatile investment arenas we’ve ever seen, and a long/short strategy means you can make a profit as prices rise and fall, both of which inevitably happen throughout the year.
The key is being able to identify when assets are undervalued and when they’re overvalued.
As we explained in the last section, there was a lot of money to be made in short selling Bitcoin over the past 12 months.
Shrewd investors knew prices couldn’t remain at the $20k for long; they knew Bitcoin prices were overvalued and its value would have to drop sooner or later.
Taking a short position on Bitcoin when its prices were at their highest and then paying back at the peak of the “crash” was the most prominent Bitcoin opportunity we’ve seen so far – by a long margin.
In the space of two months, roughly $13,000 per coin was up for grabs as prices plummeted from almost $20k to under $6k.
Better yet, if you took long positions on Bitcoin back when prices were under $1,000 and took short positions while they were approaching $20k, you would have pocketed on the long-term value increase and made a serious profit on top of the early-2018 crash.
With a cunning long/short cryptocurrency strategy, you can protect your investment from market volatility and profit from prices as they move both ways.
Now, let’s look at how you can long/short cryptocurrencies.
How To Long Cryptocurrencies?
Taking a long position on cryptocurrencies is the most straightforward investment strategy. In this case, you’re buying into currency on the basis that its value is going to increase over time.
This involves buying coins outright, which means you own the assets yourself and the market value of your cryptocurrencies determines your profit.
In other words, this is the classic buy low and sell high approach to investing in the technology.
#2 First, you’ll need to create an account with one of these exchanges and then buy your cryptocurrencies. In some cases, you’ll need to buy Bitcoin using fiat currencies (USD, GBP, EUR, etc.) and then exchange them for other currencies if you want to invest in altcoins like Ripple or Monero.
#3 Make sure you can actually buy Bitcoin directly from your exchange platform, though. Many only allow you to buy through contracts for difference (CFDs) which means you won’t actually own the coins you “buy”.
This is one of the reasons we recommend eToro as a crypto exchange platform – you can buy Bitcoin directly from the platform or invest via CFDs and other options.
#4 The key part is identifying which cryptocurrencies you think will increase in value over time and this is where it’s important to look at the technology behind the coins you invest in.
These are technological solutions that hold real-world value beyond the price of the coins offered by these crypto providers – so keep this in mind when you’re taking a long position on any cryptocurrency.
You want to invest in the ones that will be around long after the ups and downs of this volatile market have settled and the world is using cryptocurrencies as a standard payment option.
#5 Once you’ve decided which coins to invest in, the crucial factor is deciding when to buy.
You’d be kicking yourself now if you went long on Bitcoin last December when prices were pushing $20k. Of course, Bitcoin prices are projected to far exceed $20k over the next few years but you would have an anxious wait on your hands if you bought when prices were at their highest.
More to the point, anyone with any investment experience could tell those prices had to come down before they could start a more sustainable rise.
At the opposite end of the spectrum, buying in February, when prices dropped below $6,000, was the best time to invest in Bitcoin this year and this shows how critical timing can be over the space of just two months.
How To Short Cryptocurrencies
Short selling cryptocurrencies is a little more complex in principle than going long but it’s easy enough to get your head around.
Instead of buying Bitcoin or altcoins when you expect them to increase in value, the plan is to borrow them when you anticipate a drop in value.
When Bitcoin prices are set at $12,000, you borrow and sell them at the current market value with the aim of paying back your lender when rates are lower, which means you get to keep the difference.
You borrow and sell coins at $12k a piece and then pay back your lender when the market price is lower – for example, $9k, which would result in a $3,000 mark up on each coin.
Not too shabby.
There are some ways you can short cryptocurrencies so let’s run through these now.
Margin trading is where you borrow Bitcoin or other coins from a broker, which you can then trade with and repay later.
As you’ve guessed by now, the aim is to borrow coins while the price is high, sell them at inflated market value and then pay pack your broker when prices are significantly lower.
Of course, there are fees involved and things could go the other way if you have to pay back your coins when prices are higher than the time of lending.
Contracts For Difference
This is the most common way of investing in cryptocurrencies without actually buying coins yourself.
Essentially, what you’re doing with a CFD is betting that prices for a given cryptocurrency will either increase or decrease.
Unlike margin trading, your not borrowing any coins through a CFD; you just place your stake on the whether the value is going to increase or decrease.
This allows you to simulate short selling by betting on price drops and the key benefit is you don’t have to worry about actually buying or selling anything.
You just sign your contract and let the market determine things for itself.
When you sign a futures contract, you agree to buy Bitcoin or another cryptocurrency on a specific date for a fixed fee.
The aim is to agree on a fee that’s lower than the market price on the date you have to buy so that you can essentially buy your coins at a price lower than the market value when your contract expires.
Futures trading isn’t as widely available as CFDs, but they are growing in popularity.
Direct Short Selling
Direct short selling doesn’t involve any borrowing or contracts at all. Instead, you buy your coins as normal and then sell them when you feel the market price is overvalued.
Next, you use your profit to buy more coins when prices become undervalued and grow your investment by market fluctuations – an ongoing process of buying low and selling high.
There are other ways you can short cryptocurrencies, including binary options trading, but they tend to be high-risk and expensive.
We recommend sticking to the options above, especially if you’re still new to investing outside of cryptocurrencies or long/short strategies.
What Makes a Good Long/Short Strategy?
The best long/short strategies combine both methods to create a more diverse and profitable investment portfolio.
By going long, you’re investing in the long-term profitability of your cryptocurrencies, but you can also profit from price drops with some smart short selling.
The key thing to remember with your overall long/short strategy is that prices always come down faster than they go up, but they also go up the majority of the time.
As David Gardner puts it:
“Stocks always go down faster than they go up, but they always go up more than they go down.”
In fact, the guys over at eToro suggest cryptocurrency prices increase two-thirds of the time and spend the final third the year in decline. Which describes Bitcoin prices for the past 12 months fairly accurately:
A great long/short strategy for Bitcoin investors over the last year would have been to go long on the cryptocurrency once prices started to climb after dipping below $1,000 and then watching their value increase.
At this stage, you’d be looking at $8 profit per coin on your long positions, which is a pretty impressive return in itself.
However, going short on Bitcoin when prices were climbing towards that $20k barrier, using one of the short selling strategies we mentioned earlier, means you could have made huge profits from the Bitcoin crash that started in December last year.
Prices plummeted from almost $20k to under $6k, and you can guarantee short sellers made insane amounts of money in those early months of 2018.
There are risks with short selling, of course, but you can use it to offset the risks of going long in the opposite direction, which is vital in volatile marketing like cryptocurrencies.
A long/short strategy won’t protect you from all risks, but it will put you in a strong position to profit from prices as the rise and fall.
How Do I Get Started?
As we said before, many exchanges don’t allow you to buy cryptocurrencies outright, which means you can’t manage a long/short strategy – at least not from a single platform.
We’ve mentioned eToro a few times in this article, and we recommend this as the place to start if you want to implement a long/short strategy with your crypto investment.
The main reason is that eToro allows you to trade Bitcoin, Ethereum and Litecoin directly so you don’t have to buy into cryptocurrency – something many exchanges don’t approve.
Crucially, you can also use short selling tactics like CFDs on eToro, which means you can manage your entire long/short strategy from a single platform. This is important when you have to react quickly, as tends to be the case with short selling.
The main downside with eToro is that fees are higher than many exchange platforms, but you get a lot of flexibility in return.
By all means, look at other options and decide which exchange platform suits your needs but eToro gets our vote for managing long/short cryptocurrency strategies.
eToro also offers a free demo account if you feel like you’re ready to give it a go! You can sign up to eToro here.
Got any questions about long/short cryptocurrency investment? Or, perhaps you’ve already got experience that other investors could learn from. Let us know your thoughts on this strategy in the comments below!