If the situation in China, the UK, and most parts of the European Union are anything to go by, unstable economic times lay ahead. The British Pound has all but crashed, and the euro is trading at parity with the US dollar, which is a decade’s low for the currency. However, as most traders know, a currency’s dropping value doesn’t have to mean doom and gloom and can actually be a lucrative opportunity if you know how to short trade.
Short trading involves borrowing trading assets such as currencies or shares when you’re expecting them to fall in price. We know it sounds counterintuitive but stick with us. Then selling them while their price is still high, wait for the price to fall, repurchase them back, and pay your creditor, pocketing the difference.
If you still don’t understand how this works, don’t worry. Here is a list of the best forex brokers in the UK who can help you. And if that’s not enough, we will also look at how short trading currencies work and the best strategies.
How Does Short Trading Currencies Work?
When trading in currencies, you can either go long or short. Going long means you expect a currency’s value to rise, and in this situation, you want to buy it while it’s still low so it can gain and sell it for higher. This is what most people think of when forex trading. But it’s not the only way to make money in the money markets.
In hindsight, you can make money when the market moves in either direction. Therefore, when you short trade currencies, you expect their value to drop, and you take advantage by borrowing and selling them while they are still high. You then wait for their value to plummet, purchase the equivalent value of the currencies back at the lower price and pay back your debt. The difference between the price you first sold it for and what you repurchased the currency back for is your profit.
But before you can start trading, you should know a few terms and principles about short trading currencies:
- Parts of the pair: trading currencies happens in pairs of base and quote currencies. For instance, in a pair between the GBP/USD, the GDP is the base, while the USD is the quote currency.
- Pip value: currency price movement is measured in pips, and the minimum recognised pip is 0.0001 of the quote’s currency value, except for the yen, which is 0.01.
- Lot size: currency transactions occur in standardised packages of the base currency that include the standard lot size of 100,000 units, a mini lot size of 10,000 units, and a micro lot size of 1,000 units.
For instance, let’s say you’re short trading a GBP/USD pair. If the exchange rate is 1.2522, which essentially means that 1 pound is going for $1.2522. And if, in this case, you’re expecting the Pound’s rate to drop, and it moves to 1.2500, you would earn 22 pips on the trade. To calculator the value of how much you’d earn, you take the quote’s currency pip value which in this case is 0.0001, and multiply it by the exchange rate, 12522, and the lot size you bought; for this case, let’s say it’s the standard—adding up to $12.522.
When we factor in your 22 pips, your total profit would add up to $275.484 minus any commissions and fees you’d have to pay your broker.
The best trading strategy to apply while shorting currencies is to use a stop-loss order. A stop-loss puts a cap on how much you can lose if a trade goes in the opposite direction you were expecting. In short trading, for instance, if you don’t have a stop-loss order with your broker. If the currency you were expecting to fall starts rising, there is no limit to how far it can and how much you can lose.
Even though we’d all like to be in stable and predictable economies, the fact is that there are times when things will get shaky, and volatility starts to kick in. For most, this marks a time of instability and challenging economic conditions. However, it need not be. You can short the markets or play the long game to make the most out of any prevailing conditions.