‘Short selling’ is perhaps one of the most misunderstood terms in the world’s financial markets, with this commonly and mistakenly cited as one of the key drivers of the 2008 financial crisis.
This represents a huge misconception, as while short selling remains a relatively controversial practice in some markets (such as stocks), it’s perfectly legal and widely used across an array of asset classes.
The practice is also far less questionable when applied to the forex market, but why is this the case and how can you successfully short sell a currency?
What Does it Mean to Short Sell a Currency?
In general terms, short selling refers to any position that seeks to profit from a financial instrument’s decline in value. To facilitate this, a trader will essentially ‘borrow’ an asset that they don’t own directly from a broker, before selling this on the market.
This is how short selling works in the stock market, with the fundamental concept of borrowing shares at the heart of the practice’s controversial nature.
Beyond this, critics also claim that short selling amounts to market manipulation, with this observation borne out as investors began to profit from the collapse of certain firms and industries through the coronavirus pandemic.
The process is markedly different when shorting currency, however, thanks largely to the derivative nature of this asset class and the way in which it’s traded. In this instance, you’re essentially betting that a currency will fall in value in relation to another, with the asset traded in a variation of major, minor and exotic pairings.
For example, if you decide to short the EUR/USD pairing, you’re effectively selling Euros (the base currency) and buying US dollars (the quote currency).
What You Need to Consider and How to Minimise Risk
According to Tickmill.com, 90% of the forex market participants are currency speculators. When shorting currency pairs, you’ll need to monitor price changes and fluctuations in real-time. These are measured in ‘pips’, with a single unit equivalent to 0.0001 of the quote currency value (except when trading the popular Japanese yen).
Interestingly, when you open your welcome bonus forex $30 account, your broker may give values out to one digit past the pip, or one-tenth of a pip or pipette).
You’ll also need to consider lot sizes as a short seller, with most currency transactions carried out in a so-called “standard” lot of 100,000 units of the base currency. They can also be completed in mini lots (10,000 units) and micro-lots (1,000 units) and nano-lots (100 units), depending on your desired position size and risk appetite as an investor.
As you can see, short-selling currency is a deceptively complex pastime, and one that carries considerable risk from the perspective of investors.
Given the leverage involved and margin-based nature of currency trading, short-selling can also incur huge losses, especially if your chosen pair continue to see its value appreciate over time.
So, you’ll need to focus on capping leverage and maintaining manageable position sizing, while focusing on major pairings that boast the highest possible levels of liquidity.