Forex market is one of the new concepts of investment options in India. Not all people are trading or investing in Forex market given that the past Forex broker scams and financial malpractices put fear in Indian investors. Despite the strict restrictions of the Indian government and market regulator SEBI, Indian traders still hesitate to trade in currencies in the Forex market. And those who do aren’t fully aware of practices and strategies of currency trading. One such strategy is the short-selling currency in the Forex market.
Stock traders who are trading in the equity market are fully aware of term – short selling but in here, in the currency market, people are not well familiarized with it.
In this article, we will discuss, how to short-sell currencies in the Forex market?
How does it work?
What are the risks associated with going ‘short’ and how to limit those risks?
How to short-sell currency in the Forex market?
Generally, the short-selling of currency is no different than short-selling stock. In all financial markets, you ‘go short’ by shorting a stock or currency when you believe it will fall in value. With a stock, when you believe that a particular stock will go down in value, you strategize to make a profit out of declining stock by selling it without owning it.
What you do is to borrow shares and agreeing to pay for those shares at a certain time in the future. If the stock goes down, you make the profit which equals to the difference in two values.
But, in the case of Forex trading, the idea is the same – you are betting that the currency will fall in value. If the currency will, you will make a profit out of it. Except, here the currencies are always paired; Forex transaction involves a long position and a short position.
A ‘long position’ in the currency which you believe will rise in value and a ‘short position’ to the other currency which you believe will fall in value.
How does it work?
Since currency trade in pair, so when you short-sell a currency, you’re simply placing a sell order on a currency pair where one is the base currency and other is quote currency.
For instance, INR/USD = 70.00. Here, the Indian Rupees (INR) is the base currency and US Dollar (USD) is the quote currency. This quote shows that 1 US dollar is equal to 70 Indian rupees. When you place a short trade on this currency pair, you are going short the INR and simultaneously going long on the US dollar.
What is the risk of going ‘short’ in the Currency market?
When someone ‘going long’ on a currency, the worst case scenario would be the currency value falling to zero. But, when someone ‘going short’ on currency, you are betting that it will fall in value. What if the value starts rising instead of falling? There is no limit how far the currency value could rise and consequently, how much money you could lose.
In ‘going long’ there is a limit of risk but in ‘going short’ there is no limit.
How to limit your risk?
One way to limit your unlimited risk of ‘going short’ in the currency market is to put stop-loss or limit order on your currency trade. Here, a stop-loss order will simply instruct your broker to close out a position if the currency you’re shorting rises to a certain value. This will allow you to prevent further loss if things don’t accordingly. This is an ideal way to locking profits and limiting risk on shorting the currency.
The Currency market provides a lot of services to the short-sellers in order to make potential profits but one shouldn’t forget that selling shorts is risky and it must need to be combined with good risk management.