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Last updated on May 24th, 2024
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Cate Cook

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Cate Cook
Cate is a journalist by profession who started trading shares in 2008, after which she became a full time CFD day trader for more than 10 years. She now combines her passions for writing and trading at MarketMates. Join the blog to receive the latest articles from Cate.
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Sam is the Cofounder and CEO of MarketMates. He has traded since 2008 and is the Author of the Amazon best-seller The Consistent Trader. Over 42,000 traders have taken his Advanced Forex Course for Smart Traders. Join the blog to get his latest articles.
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How Does Shorting Work in Forex? Understanding the Basics

Find out what shorting means in forex and walk through an short trade step-by-step

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Shorting, also known as selling short or going short, is a trading strategy used by investors to profit from the decline in the price of an asset.

While shorting is commonly associated with stock trading, it is also possible to short currencies in the forex market.

In this comprehensive guide, we’ll explore how shorting works in forex trading, including the mechanics, risks, and potential rewards.

What does short selling in forex mean? 

While most trading strategies focus on profiting from a rise in currency value, or ‘going long,’ forex allows traders to capitalise on a currency’s decline through short selling, also known as ‘going short.’

This approach can be particularly beneficial when economic data suggests a weakening currency, or when you anticipate a decline based on technical analysis.

Understanding forex short selling

In a traditional forex purchase, you buy currency at a specific price, hoping to sell it later at a higher price for a profit.

Short selling flips this concept. You borrow a currency pair from your forex broker and immediately sell it at the current market price.

Your aim is to repurchase the same currency pair later at a lower price, returning it to your broker and pocketing the difference.

If your prediction is correct, and the currency you shorted weakens against the other currency in the pair, you can repurchase it at a lower price.

The difference between the selling price (higher) and the repurchase price (lower) represents your profit.

For example: Let’s look at a scenario where you’re short trading the EUR/USD currency pair.

If you go long on the EUR/USD pair and ‘buy’, you are essentially betting that the euro will strengthen against the US dollar. In this case, you’re going long on the euro while simultaneously going short and selling the US dollar.

Conversely, if you sell and go short on the EUR/USD pair, you are predicting that the euro will weaken compared to the US dollar. Here, you’re going short on the euro while buying and going long on the US dollar.

In forex trading, whether you’re buying or selling a currency pair, you’re always speculating on the movement of one currency relative to another.

How shorting forex works

Here’s a practical example of how shorting forex works:

  • Suppose you believe that the EUR/USD currency pair is overvalued, and you expect the euro to weaken against the US dollar
  • You decide to short 100,000 euros (EUR) against the US dollar (USD) at an exchange rate of 1.2000, meaning you sell 100,000 euros for $120,000
  • If the exchange rate later falls to 1.1800, you ‘buy back’ 100,000 euros for $118,000, realising a profit of $2,000 (excluding transaction costs and fees)

The benefits of shorting forex

There are several benefits of being able to take short positions in forex.

Ability to profit from market downtrends:

Shorting allows traders to profit from bearish market conditions and capitalise on downward price movements in currency pairs.

This flexibility enables traders to potentially profit in both rising and falling markets, increasing trading opportunities.

Hedging against long positions:

Shorting can serve as a hedging strategy for traders with existing long positions in currency pairs

By opening short positions on correlated currency pairs, traders can offset potential losses from their long positions if the market moves against them.

What are the risks of shorting in forex?

Shorting can be a lucrative strategy for capitalising on downward price movement in currency pairs.

However, when combined with leverage, shorting carries significant risks that you should be aware of. These include:

Magnification of profits and losses:

Using leverage allows traders to control larger positions with a smaller amount of capital. For example, with leverage of 1:100, a trader can control a position size of $100,000 with just $1,000 of margin.

While leverage can amplify potential profits, it also magnifies losses. Even a small adverse movement in the market can result in significant losses, especially when trading with high leverage.

Loss potential:

Unlike buying a currency pair, where the maximum loss is limited to the amount invested, shorting carries the risk of unlimited losses if the price of the currency pair rises indefinitely.

You should carefully manage your risk through the use of automatic stop-loss orders and proper position sizing to mitigate the potential for large losses.

Steps to shorting a currency pair in forex trading:

  • Do your research and market analysis:

Conduct a thorough market analysis to identify a currency pair that you believe will depreciate in value.

Use technical analysis, fundamental analysis, or a combination of both to assess market conditions and trends.

  • Select a currency pair to short:

Choose the currency pair you want to short based on your analysis.

Consider factors such as liquidity, volatility, and correlation with other currency pairs.

  • Check the margin requirements:

Review the margin requirements for shorting your selected currency pair.

Margin requirements vary and depend on factors such as available leverage and account balance.

  • Set your entry, stop-loss and take-profit orders:

Determine your risk management parameters according to your trading plan.

Set your entry point, stop-loss and take-profit limits.

A stop-loss order helps limit potential losses by automatically closing the position if the market moves against you beyond a certain point.

A take-profit order allows you to lock in profits by automatically closing the position when the market reaches a predetermined profit target.

  • Determine your position size:

Based on your entry point, stop loss position and profit target, determine your position size.

This will be based on the risk management strategy you decided on when you wrote your trading plan.

Your position size will depend on the percentage of your trading capital that you are prepared to risk on one trade, and the potential risk/reward ratio you’ve decided upon for the trade.

  • Enter your short position:

Log in to your trading platform and navigate to the order entry screen.

Select the currency pair you want to short and choose the ‘sell’ option.

Specify the trade size (lot size) and then set your trade parameters such as your stop-loss orders and take-profit levels.

  • Monitor your trade:

Keep a close eye on the market and monitor the performance of your short position.

Watch for any changes in market conditions or unexpected news events that may impact your currency pair’s price.

  • Manage your trade:

Adjust your stop-loss and take-profit levels as needed based on evolving market conditions.

Consider scaling out of the position if the market moves in your favour.

  • Close your position:

When you’re ready to close the short position, navigate to the order entry screen on your trading platform.

Select the currency pair and choose the ‘buy’ option to exit the position.

Review the trade details and confirm the order to close the short position.

  • Review and analyse:

After closing your short position, review your trade to evaluate its performance.

Analyse what went well, and what could be improved for future trades.

Get this week's best trading content

Lessons for all levels of trader. Nail the basics, master your mindset and learn advanced techniques.

Cate Cook

Cate Cook

Cate is a journalist by profession who started trading shares in 2008, after which she became a fulltime CFD day trader for more than 10 years. She now combines her passions for writing and trading at MarketMates. Join the blog to get the latest articles from Cate.
Cate Cook

Cate Cook

Cate is a journalist by profession who started trading shares in 2008, after which she became a fulltime CFD day trader for more than 10 years. She now combines her passions for writing and trading at MarketMates. Join the blog to get the latest articles from Cate.

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General Advice Warning: From time to time, you may receive general non-binding advice from us. This information is intended to be general and is not personal financial product advice. It does not take into account your objectives, financial situation, or needs. Before acting on any information, you should consider the appropriateness of the information provided and the nature of the relevant financial product having regard to your objectives, financial situation, and needs. MarketMates is not liable for or held responsible for any loss, financial or otherwise in relation to information received from MarketMates.

© 2024 – MarketMates.
All rights reserved | Privacy Policy | Risk Disclosure

General Advice Warning: From time to time, you may receive general non-binding advice from us. This information is intended to be general and is not personal financial product advice. It does not take into account your objectives, financial situation, or needs. Before acting on any information, you should consider the appropriateness of the information provided and the nature of the relevant financial product having regard to your objectives, financial situation, and needs. MarketMates is not liable for or held responsible for any loss, financial or otherwise in relation to information received from MarketMates.

© 2024 – MarketMates.
All rights reserved | Privacy Policy | Risk Disclosure

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