Short Selling: How Traders Profit from a Fall

In the Crypto Assets and stock markets, short selling is a trading strategy that is often misunderstood yet widely applied. Many people only know about buying the pump, but they do not realize that short selling can allow you to profit even when prices fall.

The Essence of Short Selling: Sell First, Buy Later

In simple terms, short selling is when you first sell borrowed assets at the current price, and then buy them back at a lower price after the price drops, taking the difference as profit. Traders who establish short positions are pessimistic about market trends; they “bear” a certain asset.

This strategy seems simple, yet it requires bearing multiple risks. To execute a short sell, traders need to borrow assets from an exchange or broker, which means providing collateral, paying interest, and handling fees. This is the key distinction from simple buying and selling — you are not selling something you own, but rather selling something borrowed.

Practical Case: Comparison of Short Selling Bitcoin and Stocks

Bitcoin Short Selling Example: Assuming the price of Bitcoin is $10,000, you borrow 1 BTC and sell it at this price. If the price falls to $9,500, you buy back 1 BTC and return it, making a profit after deducting interest and fees. However, if the price instead rises to $10,500, your repurchase cost will increase, resulting in a loss.

Stock Short Selling Example: Investors are bearish on a company's stock, borrowing 100 shares and selling them at $50. If the price falls to $40, they buy back for $4,000 and return, making a profit after expenses. Conversely, if it rises to $60, they face a loss of over $1,000.

Two Forms of Short Selling

Short Selling with Coupons is a mainstream practice—traders actually borrow and sell real assets, with relatively controllable risks.

Naked short selling refers to selling securities that have not been borrowed, a practice that carries extremely high risks and is restricted or prohibited in most markets due to its potential to lead to market manipulation.

Cost Structure of Short Selling Operations

Short selling is not free. Traders need to understand three core cost factors:

Initial Margin is the entry cost — the stock market usually requires 50% collateral, while the Crypto Assets market varies due to leverage multiples. With 5x leverage, a $1,000 position only requires $200 in collateral.

Maintain Margin ensures that the account has sufficient funds to cope with losses. If the margin level is too low, the exchange will issue a warning and may even actively liquidate positions, resulting in unexpected losses.

Borrowing Costs include interest and fees, which can eat into profits, especially when short positions are held for extended periods.

The Double-Edged Sword of Shorting: Returns and Risks

Advantages: Short selling allows traders to maintain profitability during bear markets without passively waiting for a rise. As a hedging tool, it can offset losses from long positions, especially in highly volatile markets. Some market participants even believe that short selling aids price discovery by exposing overvalued assets, thereby enhancing market efficiency.

Hidden Crisis: The biggest risk of short selling is unlimited loss. If the price continues to rise, your losses will keep expanding. A short squeeze event (where a large number of short sellers are forced to close their positions, which in turn pushes the price higher) can instantly destroy the positions of short sellers. The GameStop event in 2021 is a typical case—retail investors united to drive up the stock price, forcing short sellers to cover with huge losses.

In addition, regulatory authorities often impose short-selling bans and force liquidations during market crises. The obligation to pay dividends in the stock market can also increase costs.

Market Ethics and Regulation

Short selling has always been a topic of controversy. Critics argue that it exacerbates market declines and harms company employees and stakeholders. Supporters, on the other hand, contend that it enhances market transparency. To balance both sides, regulators have implemented “rules prohibiting short selling below the flat” to restrict short selling during rapid declines and require large short positions to be disclosed.

What Is the Ultimate Insight of Short Selling

Short selling is an essential tool for professional traders and a defensive measure for risk managers. Whether used for speculation or hedging, it holds an important position in both traditional markets and Crypto Assets markets. However, every trader should recognize that short selling is not a zero-cost strategy—borrowing fees, margin requirements, short squeeze risks, and forced liquidation threats can alter the outcome in an instant.

Understanding the mechanism, costs, and risks of short selling is essential for making more informed decisions in the market.