Shorting Forex: Overview, How To & Tips

Historically, going short was commonly used in the commodity markets primarily under negotiated contracts. However, this strategy has spread to other financial instruments in current financial markets with shorting in forex being the most prevalent. Traders use short selling to create trading opportunities from market forecast analysis or to hedge currency exposure ^[1].

Let’s explore the basics of shorting in forex, the steps involved, and risk management using the EUR/USD pair as an example.

What is Short Selling

Short selling or going short is a strategy that involves taking a position against the market. Therefore, traders sell assets on the assumption that their prices will fall. In this scenario, the more prices fall, the bigger your potential trading opportunities.

How Shorting Forex Works

In forex terms, shorting forex is the same as opening a position to ‘sell’ a currency pair. When a trader speculates that the value of a currency will fall, they can open a position to ‘sell’ the currency. If the price of the currency falls in value, the trader can make a profit relative to the degree that the price falls. This forex trading strategy can work  in your favour when the market is either volatile, or experiencing a downturn.

Typically, traders open long positions in bullish scenarios, and short positions in bearish markets. Shorting currencies is an important part of forex because when you trade, you are essentially going long on a particular currency while simultaneously selling another. Therefore, trading forex pairs is actually predicting that one currency will depreciate in value compared to the other, and vice versa ^[3].

Can You Short Forex

Shorting in the forex market is indeed possible, and actually quite common as numerous traders engage in this type of trading regularly. Compared to the stock market, the risks associated with shorting in the forex market can be relatively lower due to the interconnected nature of currencies within a currency pair. 

For an exchange rate to experience a significant increase, there must be substantial shifts in the prevailing market conditions. The current exchange rate is determined by the interplay between the values of the two currencies involved in a pair.

How to Short Forex

If shorting forex sounds intriguing to you, here are some of the key steps you’ll need to factor in when you want to short forex pairs: 

• Research to find a pair you would like to trade
• Carry out both fundamental and technical analysis on that pair
• Choose a trading strategy and understand your risk exposure
• Open a trading account
• Deposit funds
• Open and monitor your position
• Close your position

Researching which pair, you would like to trade helps you understand the different pairs available, as well as their liquidity and volatility. These two factors are very important for traders who want to take bigger risks by opting for forex pairs with higher volatility, and for scalpers and other traders who want to create quick market opportunities by choosing pairs with more liquidity.

Shorting Forex Using CFDs

Many new traders are often confused by the term “short selling” primarily because they don’t understand the concept of selling something you don’t own.

This relationship started in the stock markets long before forex was introduced in the financial markets. Traders came up with a mechanism that allows them to speculate on the downward movement of the price of a stock. Traders may not own the stocks they are betting against, but someone else ultimately does. Brokers exploit this opportunity to match clients that hold the stock, with clients that want to sell it without necessarily owning it.

It is essential to understand how transactions are handled in the forex market because the process of shorting a currency pair is handled differently from stocks. 

A currency pair mainly involves a quote currency and base currency. Therefore, currency quotes are always provided as two-sided transactions. Short selling a currency pair is simply buying the quote currency and selling the base, expecting the value of the currency pair to fall ^[2].

Examples of Shorting Forex

For example, let’s say we opened a short position for $50,000 when the price of EUR/USD was at 1.30. If the price moves lower, that presents an opportunity for potential returns and vice versa. 

If we expect further decline in the price, we may choose not to close the entire position, but instead close half the position while retaining the ability to stay in the trade. 

Risk Management in Short Selling Currencies

Shorting in forex can be very risky because there’s no maximum loss on trades. Theoretically, forex prices can rise to infinity and losses are unlimited. On long (buy) trades, there’s a maximum loss level because the value of currencies cannot fall below zero.

How can you mitigate short selling risks?

• By implementing stop losses to lock in profits and reduce losses
• Staying up to date with the latest financial and economic events and news for potential downside risks
• Monitoring key levels of resistance and support for entry and exit points

Employing price alerts helps you stay informed even when you are away from your trading platform. Price alerts are email or mobile notifications that keep traders informed by alerting them when a specific market reaches certain price levels. Price alerts can be preset to suit the trader’s key levels ^[3]. 

Final Thoughts

Shorting forex can be done anytime, and usually during periods of downward trends. However, it is important to exercise due diligence before initiating trades as it carries significant risk even with a promising (bearish) outlook. Shorting forex is commonly used by large institutions as hedges, as well as traders looking to take advantage of descending markets ^[4].

Start trading forex CFDs with Vantage today! Whether you’re a beginner or an experienced trader, Vantage offers live and demo accounts that cater to your needs. Sign up now to experience the benefits of trading with Vantage, including access to a wide range of CFDs and a user-friendly platform. Don’t wait any longer to start your trading journey – join Vantage now and take your first step towards success

References