How to Start Shorting Currency

Shorting a currency is usually done in response to a bearish market view on that currency’s exchange rate. In general, shorting currency involves opening a new position by selling one currency and buying or going long another currency since currencies trade in pairs in the foreign exchange market.

This means you need to decide not only which currency to sell but also which currency to buy. In this article, Benzinga explains what you need to know about shorting forex currency pairs.  

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What Does it Mean to Go Short on Currency?

The term going short originally comes from the stock market and implies having a lack of or a negative balance in an asset. Stock traders would typically need to go through their brokers and possibly pay a fee to borrow someone else’s stock to sell short shares they did not own with the intention of buying the shares back at a lower price in the future. Once the short stock position was covered by repurchasing the stock, the borrowed shares would be delivered back to the stock lender. 

Stock markets tend to be strictly regulated, and some have incorporated uptick rules to help prevent market crashes. Such rules typically state you can only go short a stock on upticks when its most recent trade price rose compared to the previous trade price. 

A significant advantage of trading in the huge and largely unregulated forex market is that shorting or selling short a currency does not involve compliance with any uptick rules like you may have come across when trading stocks. When you go short in the currency market, you don’t need to follow complicated borrowing procedures since currencies are readily available to borrow upon demand. 

Nevertheless, keep in mind that you might have to pay away an interest rate differential called a rollover if you hold a short position overnight and are short the currency with the higher interest rate. You can ask your broker or use a forex swap calculator tool to estimate what rollover fees might apply to your short currency positions. 

How Does Shorting Currency Work?

Shorting currencies occurs in many forex transactions and remains an integral part of forex trading. Whenever you make a trade in the forex market, you buy one currency and sell another since currencies trade in pairs. All new forex positions will involve shorting one currency and going long another. 

For example, if you were expecting a decline in the EU euro (EUR) but remained bullish or neutral on the U.S. dollar (USD), you could open a short EUR/USD position by selling the base currency (EUR) and buying the counter currency (USD). If you instead were to sell the USD against EUR to open a position, then you would be buying EUR and shorting the USD.   

Remember that selling the EUR/USD currency pair does not necessarily mean you are going short that pair. Going short EUR/USD implies having a net position that will benefit from a decline in that currency pair’s exchange rate. 

For example, if you are closing out a long position by selling EUR/USD, then you are not going short with that transaction, but if you have no position in EUR/USD and then sell the EUR/USD currency pair, you will have established a short position in that pair. Also, if you are long 1 lot of EUR/USD and then sell 2 lots, you will end up with a position that is net short 1 lot of EUR/USD.

6 Steps for How to Short Currency

Here are six easy steps you can follow to short a currency. Developing an elementary understanding of the forex market would be ideal before you begin trading, however. Many online forex brokers provide educational material and a demo account where you can trade risk-free with virtual money. 

Step 1: Choose the Forex Pair You Want to Trade

Before you start shorting forex currency pairs, you should first research the currency market thoroughly and pick a suitable forex pair to trade. The main reason behind choosing suitable currency pairs to trade is that certain currency pairs tend to have higher levels of liquidity and volatility. These factors could significantly affect your profitability when trading depending on your level of expertise and the trading strategy you select. 

Step 2: Perform an Analysis

After you choose a suitable currency pair to trade, you will then want to analyze the present state of market conditions before opening a trade in either direction. Forex traders typically do this using fundamental analysis or technical analysis. 

Fundamental analysis for forex traders typically focuses on the economic elements involved in the relative valuation of a currency. These fundamental elements include a country’s gross domestic product, monetary policy, benchmark interest rates, trade deficit or surplus, employment levels, retail sales and a slew of other economic data that have a bearing on the value of a nation’s currency relative to other currencies. 

Technical analysis has more to do with computing technical indicators that can provide trading signals and observing supply and demand points for the currency pair as they appear as support and resistance levels on an exchange rate chart. Technical traders also look for chart patterns and sometimes count waves using the principles of Elliott Wave Theory. 

Step 3: Choose a Forex Trading Strategy

Once you perform sufficient technical or fundamental analysis to develop a view on the future direction of a particular currency pair, the time has arrived to decide on which trading strategy you will use to profit from this view. 

For example, suppose your market analysis strongly suggests a particular currency will soften over the coming month, while another currency seems likely to strengthen. In that case, you will probably want to position yourself short the first currency and long the second currency. 

You will likely also want to consider what timeframe you intend to remain positioned in the forex market as part of your trade plan. This decision might involve deciding between scalping, day trading, swing trading and trend trading strategies, for example.

Step 4: Set up a Trading Account

If you are a retail forex trader operating for your own benefit, you'll first need to create an account with an online forex broker to make a forex trade.  Many retail forex brokers currently exist that provide you with electronic access to the forex market via an online trading platform. 

Remember to choose a well-regulated and reputable broker to entrust your margin deposit with. You will need to learn how to operate your broker’s supported trading platform that you intend to use. Many retail traders opt for the MetaTrader 4 or 5 (MT4/5) third-party trading platform suite developed by MetaQuotes that can be used free of charge in desktop, web and mobile formats. 

Step 5: Open and Monitor Your Trade

Once you open your account with an online forex broker and set up and learn how to use your chosen trading platform, you can make your first forex trade. Just because you can trade, does not mean you should trade, however. Make sure you have first developed a sound trading strategy that you incorporate into an overall trading plan to guide your trading activities.

Also, since the forex market can fluctuate sharply and unexpectedly, you should make sure to monitor your trade closely until you are ready to close it out. You can instead usually place take-profit and stop-loss orders in the market when you enter into a position to exit it appropriately according to your trading plan.

Step 6: Close Your First Position

You will eventually want to trade out of your first forex position by returning to your trading platform and selecting the option to close out the existing position. This process can vary among different trading platforms, so be sure to have practiced this procedure beforehand so that you know how to do it when the appropriate time arrives. 

Most online brokers will provide a free demo account to prospective clients that can be used to practice using their supported trading platforms. When closing out a forex position, make sure you apply any risk or money management principles you have decided to incorporate into your forex trading plan. 

Example of Shorting Currency

Shorting a currency looks a bit different depending on whether the currency being shorted is the base currency or the counter currency in a currency pair. The standard forex market notation for currency pairs puts the 3-letter ISO code for the base currency first, then puts the code for the counter-currency second and separates the two currencies with a slash “/”. An example is EUR/USD where the euro is the base currency and the U.S. dollar is the counter currency. 

For an example of shorting a currency, consider the situation where a trader currently has a flat position but has developed a bearish view on EUR/USD after doing their market analysis, so they want to short the euro versus the U.S. dollar. They already have sufficient margin deposited with their online broker to safely trade 1 lot or 100,000 euros of EUR/USD, so they open up their online trading platform and ask for a quote to sell 1 lot of EUR/USD. 

If the quote they received was 1.0700/1.0705, then they could sell 1 lot of EUR/USD at the bid side of 1.0700. Executing this foreign exchange transaction would then result in a position where they are short 1 lot or 100,000 euros and simultaneously long 107,000 U.S. dollars. 

This position would gain value whenever the EUR/USD exchange rate falls. If the EUR/USD exchange rate were to fall to 1.0600 by the time the trader closes the short euro/long dollar position out, the trader would see a profit of 100 pips on 100,000 or $1,000 in addition to any rollover fees charged or credits earned. 

Remember that when shorting a currency pair, prudence suggests placing a stop-loss buy order at your pain threshold point in case the market rises unexpectedly. You can also enter a take-profit buy order at your exchange rate target for the trade to avoid missing a drop to that level in case you are inattentive to the market for some reason. 

How to Get Started Shorting Currency

Following the steps outlined above in this article and selecting a decent online forex broker will put you on the right track to getting started shorting currency. No matter what currency you eventually decide to sell, you will need to select a currency to buy since all currencies trade in pairs in the forex market. 

Keep in mind that while shorting currency is quite easy in practice, this activity should not be taken lightly. Trading forex remains a speculative activity that can involve taking significant financial risks — including the complete loss of your margin deposit — so make sure to only trade currencies with money you can readily afford to lose. 

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