A Quick Introduction to Short Selling Currency and Its Use in the Forex Market

There are many strategies used when trading in the financial markets. Traders in the markets often buy shares or assets when they think that their value will go low. When a trader does this, the expectation is that the value of that asset will go high just in time for them to sell. By doing this, therefore, the trader is able to make some money. This is what shorting is all about in the markets. In the currency market, this process is a bit different since it involves two currencies where the short position sees one currency in the pair falling and the other one rising. Let us look at the strategy in detail.

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Short Selling in the Currency Market

As stated in the introduction, short selling in the forex market involves a pair of currency. Take the USD/EUR pair for instance. This pair comprises of base currency (the USD) and the quote currency (EUR). If the quote of the currency is USD/EUR=0.88 and the trader decides to go short, then they will basically be short selling the base currency while going long on the quote currency. In the hypothetical situation here, quote indicates that 1 USD equals 0.88 EUR.

The Premise of Shorting in the Forex Market

The premise of every trade done by a trader is that their move will allow them to make a profit. When a trader is short selling the USD therefore, they are expecting that at a point in time, the USD will be lower in value compared to the EUR. The ideas that inform such a move come from the research done on the market. Short selling in the currency market is pretty straightforward. There are no special requirements that a trader needs to comply with, nor are there special rules on the trade.

Risks Involved in Short Selling

Like in every other market, there are risks involved in going short particularly in the currency market. When a trader decides to go short, they are putting themselves at risk of losing money exponentially. This is because short selling assumes that the price will fall. If the price decides to rise however, there is no upper limit on how much the price of the currency can rise. Long selling does not have such a risk since the price of the currency can only fall to zero and not beyond. Traders thus are exposed to risk when going short and there needs to be a means of limiting the risks.

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How to Limit the Risks?

Fortunately, there are a number of ways through which a trader can limit the risks of short selling. One of the most effective ways of doing this is by using a stop loss. Stop losses are used across the financial markets and they provide a simple mechanism of exiting the trade when there are no profits to be made. The stop-loss tells the broker to exit the trade when a set short value limit is reached. The opposite this is placing a limit order, which exits the trade when the projected profit is met.

Crucial Issues to Note When Short Selling

As previously indicated, the forex market is great for traders who want to short sell. It is a flexible market that welcomes traders of all calibers. The market is nevertheless quite risky when it comes to short selling, especially when compared to other markets. The upper limit of loss is virtually infinite even though the lower limit of profit is 100%. Traders need to be prudent when trading in this market, therefore.

In summary

Short selling is a great way to make money in the forex market. For this strategy to succeed, the forex trader needs to be a good risk manager. The use of tools like stop loss is advised as the market is rather unpredictable. It is advisable to never risk more than 1% of the account. The basic premises of shorting in the market is similar to what is common in other financial markets. With proper strategies on risk elimination, there is a lot to be gained when shorting in the foreign exchange market.

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