Shorting a Currency – How Does it Work?

forex

While the concept of ‘shorting’ a financial instrument is considered by some to be controversial, it’s undoubtedly an inherent part of trading currency on the forex market.

From Andy Krieger’s decision to short the Kiwi to the tune of $300 million in 1987 to George Soros “breaking the Bank of England” and banking a cool $1 billion from shorting the pound five years later, history is also choc-full of instances where investors have profited from betting directly against the fx market.

But what exactly does it mean to short a currency, and how can you go about this as a trader? 

What Does it Mean to Short a Currency? 

Short-selling is also known as ‘going short’, while it refers to the process of betting against the market and selling an asset on the assumption that its price will fall.

This is the opposite of ‘going long’ on a particular currency pair, while the profits generated by shorting will depend on the size of your position and the extent of the price decline within the relevant period.

Typically, traders open a short position in a bearish market, which is characterised by uncertainty and slightly higher levels of volatility.

In the aforementioned cases of both Krieger and Soros, the decisions to short the Kiwi and the pound followed seismic economic and financial market contractions, which triggered huge uncertainty and caused currency prices to fluctuate wildly.

How Exactly Does Forex Shorting Work? 

Despite the seemingly extreme nature of shorting, it’s actually fundamental to the process of forex trading.

This is because whenever you trade forex, you’re going long on one currency while simultaneously selling another, creating a scenario where one asset in the pair will have to appreciate relative to the other if you’re to achieve a profit.

If you go deliberately short on a currency pair, it effectively means that you expect the base currency to weaken against the quote currency.

For example, let’s say that you choose to go short on the EUR/USD, which is the single most popular currency pair and one that accounts for more than 23% of daily trades. 

In this instance, you’re betting that the Euro will depreciate relative to the dollar, by selling the single currency prior to the anticipated decline in value. 

To begin with, you’ll be quoted the real-time price as a bid and an offer (or a sell and buy in layman’s terms). In this instance, the price for EUR/USD could be $1.2345, with a bid of $1.2335 and an offer of $1.2355.

To short the asset, you’ll subsequently open a leveraged position for the sell price of $1.2335, and if the EUR does fall further from this point on you’ll be able to bank a healthy profit.

However, you should also note that going short carries an inherent and tangible set of risks, particular as the EUR/USD (or a similar asset) retains the potential to rise indefinitely over time.

Depending on the scale of your leverage, this can translate into sustained and disproportionate losses, so it’s important that you mitigate your market exposure with relevant stops and limits through your forex trading platform.

Taking steps to cap your leverage can also help, as this automatically minimises potential losses and helps you to safeguard your capital. 

The Last Word 

Before looking to open a short position, you’ll need to thoroughly research your preferred forex pair, based on both fundamental and technical analysis and an understanding of the real-time market conditions.

Then, take steps to ensure that the trade is compatible with your wider strategy and appetite for risk, before establishing a leverage value that doesn’t exist the amount of money that you can afford to lose.

At this stage, you’ll be ready to go short and potentially profit in a depreciating market, while following in the footsteps of some of the world’s most successful currency traders.

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