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February 15, 2024

Opening of Long and Shorts

The nature of crypto markets are inherently volatile and hence a directional long or short strategy can be very profitable if the directional bias is right, risk management is adhered to and if one is consistent in the long run.

Hence, what is the meaning of opening a “long” position vis-a-vis a “short” one?

Long and Short Trading in Traditional Markets

In trading, beginning from traditional markets, a long or short position refers to a trader’s buy or sell position in an asset or security. Taking a long position means the trader has bought an asset and anticipates an increase in its price, and if the price does indeed increase, the trader can then sell or close the position at a profit.

Similarly, a short position refers to the trader selling an asset and anticipates a fall in its price. If the price does indeed drop, then the trader can buy back or close the position at a lower price, thus making a profit.

The opposite is also true if one takes a long position and the price falls, or if one takes a short position and the price increases instead. The trader then makes a loss off both positions respectively.

Longs and shorts strategies are very popular investment approaches used by hedge funds in traditional markets. In a long-short equity hedge fund, the portfolio manager takes long positions in certain stocks and industries, and some short positions in others. This can be done simultaneously taking into consideration correlation, beta (risk) and alpha (rewards) in mind using simple or more sophisticated methods like quant models or algorithmic and high frequency trading (HFT). 

They can also be done manually like how most crypto tradings do, or automated like how some exchanges allow API trading for its platform.

The ultimate objective of the long-short fund is to generate alpha in monetary terms regardless of the overall direction of the markets.

Hence, the term “hedge” in hedge funds.

What is Long and Short in Crypto Trading?

In crypto, this essentially means the same thing as mentioned above in the context of traditional markets. Only, the processes in how they are implemented differs.

Since volatility is much more rampant in the crypto markets compared to the stock, fx and commodities markets, a trader’s potential gains and losses from their resultant longs or shorts positions are much higher. 

Secondly, brokers are none existent in the crypto ecosystem, barring CFD (Contract for Differences) dealers. This then affects the process for exchanges to provide other methods for shorting, i.e., via market makers, liquidity providers (LPs) or  other institutional brokerages.

Thirdly, regulations are almost non-existent in the crypto markets and if an exchange or broker fails in this ecosystem, one cannot take their grievances to an “official” mediator or authority like the CFTC (Commodities Futures Trading Commission) or SEC (Securities and Exchange Commission) to help with their “lost” funds or “faulty” trades. This is because counterparty risks are much more prevalent in the cryptosphere because KYC (Know Your Client) processes are much more “loose” and exchanges can also be easily built without any oversight on their internal processes. 

Some crypto exchanges provide discounts and rebates if you long or short positions using tokens issued by the exchange like Binance, Huobi and many others. On CEXs (Centralised Exchanges), this is provided directly by the platform. For DEXs (Decentralised Exchanges), no such service providers are present and users borrow tokens using liquidity pools or other DeFi (Decentralised) applications.

Popular Crypto Long-Short Trading Strategies

Some such strategies include:

Market-neutral Strategy: A trader takes both long and short positions in similar crypto assets or correlated indexes. It is to offset the impact of the overall direction of the markets and profit off the relative performance of assets.

Pair Trading Strategy: Two correlated tokens are chosen. And a long versus a short position are both taken at the same time. The trader then profits off the price differential between the two.

Event-Driven Strategy: Similar to news trading in the forex markets. Taking trades based on specific events like NFPsm rate hikes in the fx markets or covid buy-on-the-dip or short on a covid scarce in the equity markets. News can also include regulatory changes like the SEC crypto rulings, hard forks like in Ethereum, Bitcoin halving news or other crypto related news.

Trend-Following Strategy: Longs and short positions are taken based on the anticipated direction of the trade. 

Written by: Sean Lai