For most of us, the concept of profiting when the price of an asset goes up is very intuitive. You simply buy at a low price, wait till it gets higher, and then sell.
Yet, there are instruments that allow you to benefit when the price of an asset goes down. In that case, you first need to borrow an asset. Then you sell it, wait for the price to go down, and buy the asset back. Finally, you return the borrowed asset and keep the price difference for yourself.
What we’ve described outlines going LONG and going SHORT.
- Going LONG (or opening a BUY position) means that you bet the price will go up. And if you are right, you will obtain a profit;
- Going SHORT (or opening a SELL position) means that you bet that the price will go down. If you are right, you will profit from it.
In this article, we will go through examples of both long and short using Contracts for Difference (CFD). CFDs allow you to benefit from the price movements of an underlying asset without actually owning the asset. It means, in our examples, we will enter the contracts for difference, but not buy the asset (Bitcoin) itself. Let’s see how that works!
Leverage - 1:2
Open BTC Price - €8,000€
Your balance - €2,000.
To make the example more realistic, we will only use €1,000 out of the available balance. The remaining amount can be used to possibly open other positions. And a small amount is necessary to cover the fees and commissions!
You believe that the price of BTC will go up. So you use your €1,000 to open a LONG ( BUY) position. With €1,000, 1:2 leverage, and the BTC price of €8,000, you can open a long for 0.25 BTC:
(€1,000 * 2) / €8,000 = 0.25
Again, since we are examining CFDs, you are not actually buying 0.25 worth of BTC. You simply open a position to be exposed to the price movements of 0.25 BTC and to benefit if the price goes up.
To be sure that you’ll capture the upswing, you choose to fix your profit when the price reaches €9,000 with a Take Profit protection order at €9,000.
To make sure that you do not lose more than what you are prepared to, you also want to fix your loss, in case a price drops all the way to €7,500. So you add a Stop Loss protection order at €7,500 too.
Imagine, you were right! And overnight the price hovered above €9,000! Your Take Profit closed your position when the price reached €9,000 and fixed your profit (so you did not have to stay up all night and refresh the screen). What is your profit like?
(€9,000 - €8,000) * 0.25 = €250
That means you made gains on the BTC price increase. Had you not used the 1:2 leverage, your gains would have been two times smaller.
You believe that the price of BTC will go down. You use your €1,000 to open a SHORT ( SELL) position. Just like in the example with a long, the input parameters allow you to open a short for 0.25 BTC.
Again, given we work with CFDs here, you do not actually sell 0.25 BTC. You open a position to be exposed to the price movements of 0.25 BTC and to benefit if the price goes down.
You want to lock in your profit at €7,000. So you add a Take Profit protection.
You also want to limit your potential losses, if the price rises, by adding a Stop Loss at €8,200.
Let’s imagine your intuition was right, and the price did go down. Your position closed when the price reached €7,000 per BTC, so you are in for some gains:
(€8,000 - €7,000) * 0.25 = €250
It means, with your short position, you profited from the BTC price decrease. As in the previous example, without 1:2 leverage, your gain would have been two times smaller.
Of course, in real life, there might be times when the price does not move the way you wish. To check your understanding of LONG and SHORT positions, work through examples when the price moves in the direction, opposite from what you’ve expected.
If you feel confident to put your knowledge to practice, see what’s possible with CEX.IO Broker!