Short Forex: Selling Currency Explained
Short selling currency in forex trading involves taking positions under the pretence of bearish sentiment. Short selling forex means to sell high then buy low and is often used by traders to hedge currency exposure or simply to profit from the forecasted analysis.
This article explores the basics of short-selling forex, using the GBP/EUR currency pair as an example to explain the steps involved. It will also cover suitable risk management as short selling comes with a high risk. Trading cfds with this approach must be cautioned as these are complex instruments and can stop you out rapidly due to leverage when market volatility is high.
What do short-selling currencies involve?
In the forex market, transactions are handled differently to stocks which means the process of short selling a currency pair is very different. Firstly, a currency pair involves a base currency and quote currency as seen in the image below.
How to short forex: GBP/EUR short selling example
Taking a short position in forex involves understanding currency pairs, trading system functionality and risk management.
First, each currency quote is provided as a ‘two-sided transaction’. This means that if you are selling the GBP/EUR currency pair, you are not only selling Pounds; but you are buying Euros. Because of this, no ‘borrowing,’ needs to take place to enable the short sale.
The base currency is the first currency listed in a currency pair. In the example above, this is the British Pound. The base currency is also the ‘transaction currency,’ which is what you are selling or buying in the trade.
The quote currency is the second currency in a currency pair. In short selling forex, this is the Euro. The quote currency is what you are using to buy the base currency.
Want to sell the GBP/EUR?
Just click on the side of the quote that says ‘Sell.’ After you have sold, to close the position, you would want to ‘Buy,’ the same amount (if you end up buying at a lower price than where it was sold, you would end up with a profit). You could also choose to close a partial portion of your trade.
As an example, let’s assume we initiated a short position for 1 contract and sold GBP/EUR when the price was at 1.29.
If the price has moved lower, the trader could realise a profit on the trade. But let’s assume for a moment that our trader expected further declines and did not want to close the entire position. Rather, they wanted to close half of the position to cover the initial cost, while still retaining the ability to stay in the trade.
The trader that is short 1 contract GBP/EUR can then manually enter in 0.5, then click on the ‘Close’ button to begin the trade closing process – offsetting half of the short position that was previously held.
Our trader, at that point, would have realised the price difference on half of the trade from their 1.29 entry price to the lower price they were able to close on. The remainder of the trade would continue in the market until the trader decided to buy another 0.5 contracts in GBP/EUR to ‘offset,’ the rest of the position.
How to manage the risk of short selling currencies
Short-selling forex carries a high risk as there is no maximum loss on a trade. Losses are unlimited, as forex values can theoretically increase to infinity. On a long (buy) trade, the value of a currency can never fall below zero which provides a maximum loss level.
Cfds are complex instruments and traders are exposed to losing money rapidly due to leverage. You must decide beforehand whether you can afford the risk of losing your money. Also consider whether you understand what going short entails.
Managing risk on accounts was a trait we discovered with successful traders. Fortunately, there are ways to mitigate this short-selling risk.
5 Ways To Mitigate Short Selling Risks:
- Position size
- Implement stop losses.
- Monitor key levels of support and resistance for entry/exit points.
- Stay up to date with the latest economic news and events for potential downside risk.
- Employ price alerts on trades is a good way to stay informed when you’re away from your platform.
Short selling forex is preferred for down trending markets, however careful consideration is required before trading as it brings extra risk even with a bearish outlook. It has been utilised by large institutions/traders as hedges, or by traders looking to trade descending markets.
What is going long?
Going long is the term used when a trader buys a currency pair with the expectation that it will rise in value. They then hope to sell the pair at a higher price so they can make a profit. It is the opposite of short selling. When a trader goes long on a currency pair, they are speculating that the value of the base currency will increase relative to the quote currency. For example, if a trader buys EUR/USD, they are going long on euros and shorting dollars. They believe that as the euro strengthens, the trade will make a profit.
Risk management is essential for proper application, and the methods mentioned in this article should be given the utmost consideration as adverse movements in price can be detrimental.
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