In all financial markets, including the foreign exchange market (forex), you short-sell when you believe the value of what you are trading will decrease. With stocks, what you do is sell borrowed shares that you do not own and agree to return those shares at some point in the future. If the value of the stock declines from the time you initiate the short sale until you close it – by buying the shares back later at a lower price – you will make a profit equal to the difference between the two values.
Short Selling in the Forex Market
Short selling in the forex market follows the same general principle – you are betting that the currency will decrease in value, and if that happens, you will make profits. However, this is a bit more complicated. This is because currencies are always paired: every forex transaction involves a short position in one currency and a long position (betting on increase in value) in the other currency.
Placing a Sell Order
Another difference between short selling in the stock market and the forex market is that in the latter, you do not need to borrow a certain amount of the currency you wish to short sell. Short selling in forex is as simple as placing a sell order.
Parts of the Pair
All currency pairs have a base currency and a quote currency. The base currency comes first in the currency pair, and the quote currency comes second. So in the GBP/USD pair, the British pound is the base currency, and the US dollar is the quote currency.
Point Values
Price changes are measured in pip units. For all currencies except the Japanese yen, a pip equals 0.0001 of the value of the quote currency. When yen is the quote currency, a pip equals 0.01 yen. (Brokers may sometimes quote values to one decimal place beyond the pip – a pipette or fractional pip.)
Contract Sizes
Many currency trades are executed in a standard lot, which equals 100,000 units of the base currency. They can also be executed in mini lots, which equal 10,000 units, or micro lots, which equal 1,000 units.
Suppose the GBP/USD price is 1.3452, meaning that the British pound is worth 1.3452 dollars. If you expect the pound’s value to fall against the dollar, you will sell the currency pair at that price. If you buy the pair after the price drops to 1.3441, you have made 11 pips.
The math to find the value of a pip in the quote currency for a standard lot of the base currency is 0.0001 (one pip) / 1.3452 (exchange rate of the pair) × 100,000 (lot size) = $7.43. This means that with an upward movement of 11 pips, you would make 11 × 7.43 = $81.73, excluding any commission.
Note: Brokers may charge a specific commission – perhaps $5 – on each standard currency trade they execute, or they may keep the difference between the bid and ask price for each transaction.
Reducing Risk
If you are considering short selling a currency pair, you need to keep risk in mind – especially the difference in risk between “going long” and “going short.” If you decide to go long on a currency, the worst-case scenario is watching the value of the currency drop to zero. While this bet would be bad for your investment portfolio, your loss would be limited because the value of the currency cannot fall below zero.
On the other hand, if you are short selling a currency, you are betting that it will go down, while its value can rise and continue to rise. Theoretically, there is no limit to how high the value can go, and thus there is no limit to the amount of money you can lose.
One way to mitigate risk is to place stop-loss or limit orders on your short position. A stop-loss order instructs your broker to close your position if the currency you are short selling rises to a certain value, protecting you from further loss. A limit order, on the other hand, instructs your broker to close your short position when the currency you are selling drops to the value you specify, securing your profit and eliminating future risk.
Source:
https://www.thebalancemoney.com/what-it-means-to-go-short-in-investment-terms-1344960
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