Short selling enables traders to place lucrative forex orders even in a falling market. It does not require a lot of money to be invested upfront, hence, it suits beginner traders to start their trading journey. In our article, let us understand what short selling exactly is and how you can benefit from it.

What is short selling?

Short selling is when you open a ‘sell’ position to profit from the bearish market. In this case, you borrow a currency pair at a margin from the forex broker in the falling market and wait for the market to fall further. Once it does, you repurchase the currency pair at the lower price, return the borrowed amount and keep the difference as your profit. You make profits to the degree of the fall in the currency pair’s price. For example, if you expect the price of the USD to fall in the near future against the sterling pound, you will short USD/GBP. If the currency pair is trading at 1.2 and you expect it to fall to at least 1, you will borrow the currency pair at a margin for an exchange rate of 1.2. Margin refers to the percentage that you need to deposit against the total deposit. If the margin is 3%, you will deposit 3% of 1.2. Further, as the trading day is about to end, the currency pair prices decrease to 1. At this point, you will open a long position and buy USD/GBP at 1, pay back your broker with the currency pair and keep 0.2 as your profit from short selling.

Benefits of short selling forex

  • Short selling is leveraged trading which means that you can trade with borrowed funds, increasing your monetary accessibility in the forex market.
  • Since you can short sell trade with margin, you are only required to invest a certain percentage of the initial trading value, making it possible for you to earn higher profits with smaller investments.
  • It doubles your profit opportunities as you can benefit not only from rising but also from falling markets.
  • It acts as a risk protection in a diversified portfolio as you can hedge long positions with short positions.

How does short selling work?

Short selling works on a pessimistic approach where traders expect the market to continue a bearish momentum. They identify opportunities to make a profit when the currency pair prices are falling. This is done through fundamental and technical analysis to identify a weak trend in the market. When a downtrend is identified and expected to worsen, traders enter short or sell positions to profit from the falling markets and mitigate bearish momentum losses.

Indicators for short selling a trade

1. Relative Strength Index (RSI)

RSI is a technical indicator that identifies overbought and oversold market conditions. It oscillates between 0 and 100. You can short a trade with the RSI indicator as soon as the RSI line crosses the value of 70 from above, indicating an overbought market. The overbought market condition expects a strong bearish reversal, enabling traders to profit from the falling market.

2. Stochastic Oscillator

A Stochastic Oscillator is a momentum indicator that compares the closing prices of the currency pair over a period of time to identify if there is bullish or bearish market momentum. It ranges between 0 to 100 to indicate oversold or overbought market conditions. When it gives a value equal to or above 80, it indicates an overbought market situation where traders can enter short positions to benefit from the falling market.

3. Moving Averages

Moving Averages is a trend indicator that indicates if there is a continued uptrend or downtrend in the market by soothing out currency pair prices. When the moving average line falls, it indicates that there is a continued downtrend in the market. This provides traders with a signal to short the market.

How to short a currency

1. Choose a forex pair

Determine the forex currency pair that you want to trade after opening a forex trading account. Most trading platforms come with a news and analysis section that will make it easier for you to choose a currency pair with an expected downtrend.

2. Apply technical indicators to the currency pair’s chart

After you choose the currency pair you want to trade, apply technical indicators like RSI or the stochastic oscillator to the price chart. This will provide you with confirmed market signals and indicate if there is a strong downtrend in which you can short the trade. The research will help you gain deeper knowledge about the currency pair.

3. Use a forex trading strategy

Define or choose from an existing forex trading strategy to select the market entry, exit, and risk levels. Sticking to this strategy will enable you to place successful trades and stay away from volatility risks.

4. Identify a bearish momentum

Identify a falling market for the currency pair you have chosen. According to your trading strategy, enter a short position as per your trading requirement.

5. Monitor the market

Stay in the trade till the market is expected to continue in the downtrend. If the market reverses and starts increasing, exit the trade immediately to avoid losses. On the other hand, exit the short trade in the falling market once you reach your expected profit levels. Do not stay tied up in the same trade for a long period of time, as a long-term bearish market has a tendency to reverse into a bullish momentum at any time.

Short sell your first currency pair today

Short trades can be initiated anytime during the day and closed before the trading day ends, making it an incredible short-term trading strategy. Sign up for a live trading account or try a demo account.

Disclaimer: 

  • All material published on our website is intended for informational purposes only and should not be considered personal advice or recommendation. Traders should carefully consider their objectives, financial situation, needs, and level of experience before entering into any margined transactions.