How to Short Forex

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]. 

Short selling is a strategy where investors sell borrowed assets in the hopes of profiting from a subsequent price decline by buying them back at a lower price. 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.  

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

What is Short Selling in Forex 

In forex terms, short selling, also known as shorting or going short, is a trading strategy where a trader sells a currency pair with the expectation that its value will decrease in the future. This forex trading strategy can work in your favour when the market is either volatile or experiencing a downturn.  

How Shorting Forex Works 

Typically, traders go long in bullish scenarios and go 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 expecting that one currency will depreciate in value compared to another, and vice versa ^[2].  

Let’s have a look at how shorting forex works using currencies such as the Australian dollar and the US dollar.  

Example of Shorting Forex 

During the early months of 2020, the world faced an unprecedented economic downturn primarily due to the COVID-19 pandemic. Global trade disruptions, travel bans, declining consumer demand, and sweeping lockdowns severely impacted economies worldwide. Australia, with its significant reliance on exports, especially to China, was not immune to this economic shock. 

As a result, the AUD/USD exchange rate dropped from $0.7017 on 1 January 2020 to $0.5741 on 19 March 2020, marking its lowest point in 2020 ^[3]. This significant decline in value highlights the volatility and potential for gain in the currency market, particularly for those who engage in strategic trading. 

For example, let’s say we opened a short position for $50,000 when the price of AUD/USD was at 0.70. If the price moves lower, that presents an opportunity for potential returns and vice versa. 

If we expect a 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. 

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:   

Open a trading account 

Before delving into the world of Forex trading, you need to set up a dedicated Forex trading account with a reputable broker. This account will serve as your main platform for executing trades, monitoring and managing trades, and accessing market analysis tools. 

Find a forex pair you would like to trade 

Once your account is ready, it is time to identify a currency pair that aligns with your trading interests and market expertise. This choice is often based on a number of factors including but not limited to economic stability, geopolitical events, and trade relations between the countries of the two currencies. 

Carry out research on the forex pair

Thoroughly analyse the historical performance, current trends, and potential future movements of your chosen forex pair. Leveraging resources like news updates, economic indicators, and expert forecasts will enhance your understanding and decision-making. 

Pick your forex trading strategies 

There are various strategies in forex trading, such as scalping, day trading, or position trading. Select a method that suits your investment horizon, risk tolerance, and market analysis, ensuring it aligns with your overall trading goals. 

Open, monitor and close your position 

Once you’ve made your trading decisions, open a position in the market. Regularly monitor its performance, staying alert to any market shifts, and when the time is right or your set conditions are met, close your position to either secure profits or minimise losses. 

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 a 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 ^[4]. 

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?

• 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 ^[5]. 

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 ^[6]. 

Start trading forex CFDs with Vantage today! Sign up now to experience the benefits of trading with Vantage, including access to a wide range of CFDs and a user-friendly platform. CFDs allow you to speculate on the price movements of various financial instruments without owning the underlying asset. 

Don’t wait any longer to start your trading journey – join Vantage now and take your first step towards success. 

References