Short-selling currencies involve booking positions depending while the market sentiment is bearish. Historically, this technique was used under negotiation contracts in the commodity market. Nowadays, in the current economic markets, short selling has become prevalent and spread to almost all financial instruments.
Traders now mostly use it to capture currency exposure or simply to extract profit from the predicted analysis. This article ventures through the fundamentals of short-selling Forex. We have used the EUR/USD pair as an instance to explain the involved steps.
Short Selling Currencies’ Involvement
People often get confused with the term “short selling” as they cannot figure out how they can sell something that they don’t own yet. This confusion had existed in the stock market before the Forex market got into its shape. Some traders wanted to speculate on a stock that was losing its price. Those traders came up with an amazing mechanism that made what they want possible.
Those particular traders might not possess such stocks to place their bet against. However, such stocks are the kinds that always remain available in the market, and someone must have to own them. It creates a perfect opportunity for brokers. They also become aware of this opportunity. They search in their client lists for the ones who are holding such assets with other clients who desire to sell them.
The overall scenario is a bit different in the Forex market than that of the stock market. Transactions get handled slightly differently in Forex trading. That’s why short-selling a currency pair deviates from the norm of the stock market. Firstly, any pair comprises two types of currencies: a base and a quote.
When someone short sells a currency pair, he actually sells the base currency and buys the quote contemplating that the current price of the pair is about to fall. In the CFD trading industry, knowing about the position when the price will gives up the upper hand. In fact, you should be able to calculate the lot size and scale your trade very precisely.
Short Selling in Forex
Buying such a position in the Forex market requires traders to understand currency pairs, risk management, and the entire system functionality of trading. First, every quote has been provided as a bi-sided transaction. For example, fancy that someone is selling the EUR/USD currency pair. For that, he has to sell Euros but to buy Dollars at the same time. Hence, any type of borrowing is not needed to trigger the short sale.
In fact, quotes are presented in a straightforward format which makes this process easier. To sell the EUR/USD pair, one has to click the sell button. To close the trade after selling, he has to buy the same amount. He would make a profit if he can buy the pair at a lower price than where the pair were sold. The profit will be, of course, excluding all the fees and commission. He can also sell only a portion of the entire position if he wants.
For instance, let’s fancy again that we have opened a transient position with $100 000. We have also sold EUR/USD at a price of 1.29. Now, when the price gets lower, we can easily detect a profitable opportunity. Now, if we can realize that the price will go further down, we won’t close the position entirely. Instead, we can sell only half of the position to cover our initial cost and retaining the ability to remain in the market.
The moment we will realize or can assume that the price won’t fall any further, we will instantly buy the same amount of that pair that we have already sold. Short selling is not a myth. Instead, it has been used by the traders for a long time to extract a profit even out of a falling price of a pair.