Introduction
Short selling currency is a trading strategy that involves taking positions based on a bearish sentiment. While it has historically been used in commodity markets under negotiated contracts, short selling has now spread to almost every financial instrument, with the forex market being one of the most prevalent. Traders use short selling to either hedge their currency exposure or profit from their forecasted analysis.
Basics of Short Selling Forex
What does short selling currencies involve?
The term “short selling” often confuses many new traders. How can you sell something if you don’t own it? This concept originated in stock markets before forex trading even existed. Traders who wanted to speculate on the price of a stock going down created a mechanism to do so.
In the forex market, transactions are handled differently compared to stocks. A currency pair involves a base currency and a quote currency. For example, in the EUR/USD currency pair, the EUR is the base currency and the USD is the quote currency. Each currency quote is provided as a “two-sided transaction.”
When you short sell a currency pair, you effectively sell the base currency and buy the quote currency, anticipating that the value of the currency pair will fall. This means you are not borrowing any currencies for the short sale.
How to short forex: EUR/USD short selling example
To short sell a currency pair like EUR/USD, you need to have an understanding of currency pairs, trading system functionality, and risk management.
To sell the EUR/USD currency pair, you would click on the “Sell” side of the quote. If you want to close the position, you would then click on the “Buy” side of the quote. By buying at a lower price than where you sold, you can make a profit (excluding commission and fees).
Let’s consider an example where we initiate a short position for $100,000 and sell EUR/USD when the price is at 1.29. If the price moves lower, you can realize a profit on the trade. However, let’s assume you expect further declines and want to close only half of the position while still retaining the ability to stay in the trade.
In this case, you can manually enter 0.5 and click on the “Close” button to begin the trade closing process for 50,000 units, offsetting half of the 100,000 short position you previously held.
How to manage the risk of short selling currencies
Short selling forex carries a high level of risk, as there is no maximum loss on a trade. Losses in forex can theoretically increase to infinity, as there is no limit to how much a currency value can fall. In contrast, on a long (buy) trade, the value of a currency cannot fall below zero, which sets a maximum loss level.
To manage the risk of short selling currencies, it is essential to implement stop losses. These are predetermined levels at which your trade will automatically close if the market moves against you. Monitoring key levels of support and resistance can also help in determining entry and exit points for your trades.
Staying up to date with the latest economic news and events is crucial for identifying potential downside risks. Economic factors can significantly impact currency values, so being aware of any developments is important in managing your trades. Additionally, employing price alerts allows you to stay informed even when you’re away from your trading platform. These notifications can be set to update you when specific price levels are reached on the market.
Considerations and Further Reading Recommendations
Short selling forex is typically favored in down trending markets. However, it brings extra risk even with a bearish outlook. Large institutions and professional traders often use short selling as a hedge or to take advantage of descending markets. Proper risk management is crucial when engaging in short selling, as adverse price movements can be detrimental to your trades.
For further reading and exploring different aspects of forex trading, we recommend the following resources:
- What is the Number One Mistake Forex Traders Make?
- Traits of Successful Traders
- How Much Capital to Risk on Your Trades
- Webinars covering a variety of topics related to the Forex market
- Forex for Beginners Trading Guide
By delving deeper into these resources, you can enhance your understanding of forex trading and improve your trading strategies. Remember, success in trading requires continuous learning, sound risk management, and self-discipline.