What does it mean to short a currency and how can you short forex pairs?

What does it mean to go short on a currency?

Going short, or short-selling, means that you are betting against the market. In this scenario, you are selling an asset on the assumption that its price will fall, and the more the price falls, the greater your profit.

Going short is the opposite of going long, where you anticipate the market will rise and would open a buy position. Typically, traders open a short position in a bearish market, and they open a long position in a bullish market.

How does forex shorting work?

Shorting currencies is an inherent part of forex trading. This is because when you trade forex, you are going long on one currency while you are simultaneously selling another. As a result, when you trade forex pairs, you are actually making a bet that one currency in the pair will appreciate in value relative to the other, or vice versa.

If you went short on a currency pair, it means that you expect the base currency to weaken against the quote currency. All currency pairs have a base currency and a quote, with the cost of the pair being how much of the quote currency you would have to sell in order to buy one of the base.

In the image below, you would go short on the EUR/USD currency pair if you believed that the euro would depreciate relative to the dollar, meaning it would cost fewer dollars to buy one euro – perhaps $1.1000 instead of the current $1.2000.

In doing so, you would effectively be selling euros in the expectation that they would decrease in value over time.

You can go short on forex by trading using derivatives such as CFDs and spread bets. With these financial instruments, you will be quoted the price as a bid and an offer – or a sell and buy. For example, the price for EUR/USD could be $1.2345, and the bid could be $1.2335 and the offer $1.2355.

In this case, you would open a short position at the sell price of $1.2335 in the hope that the value of the pair will fall. If the price does fall, then you will have made a profit. However, going short carries a unique set of risks in that, theoretically, an asset’s price can rise indefinitely. That’s why it’s important to mitigate your exposure to risk with stops and limits which can reduce losses and lock in profits.

Learn more about how to manage your risk

How to short a currency

The five following simple steps will help you to short a currency:

1. Research which forex pair you want to trade
2. Carry out analysis on that forex pair, both technical and fundamental
3. Choose a forex trading strategy and check you’re comfortable with your exposure to risk
4. Create an IG account and deposit funds
5. Open, monitor and close your first position

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Watch to learn how to short a currency

Research which forex pair you want to trade

Researching the different forex pairs available to you means that you will be better informed on which pairs are the most volatile or have the most liquidity.

These two factors can be crucial for traders, with those with a higher appetite for risk choosing pairs that are more volatile; or those that are after quick opportunities for profit – such as scalpers – choosing the pairs with higher liquidity.

Carry out analysis

Once you have chosen a pair, it is important to carry out both technical and fundamental analysis before opening a trade. This is because analysis can show you whether a trade has the potential to yield a profit or not.

Technical indicators such as Bollinger bands, and Fibonacci retracements can help you to identify whether a forex pair is currently over or undersold, and they are also good indicators for volatility. This means that they are capable of highlighting whether a forex pair is about to experience a bearish reversal – a perfect opportunity to open a short position.

Choose a forex trading strategy

There are a whole host of trading strategies that you can use to your advantage during your time on the markets. For example, you could take up a short position on the EUR/USD pair with a scalping strategy, which relies heavily on quick and constant price movements during a single trading session.

Create an IG account

If you want to trade forex via spread betting or CFDs, you’ll need an account with a leveraged trading provider. You can open an IG account in minutes, and there’s no obligation to add funds until you want to place a trade.

Open, monitor and close your first position

Once you have chosen your pair, carried out your analysis and selected a strategy, you are ready to start trading. To do this, open the deal ticket for your chosen market and – to go short – select the ‘sell’ option. Alternatively, if you did want to go long, you would select ‘buy’.

From this window you can also select whether you wish to add any stops or limits to your trades, which can help to limit losses and lock-in profits. If you wish to close your position, you would simply make the opposite trade to the one which you made to open it – a buy position on a short trade, and a sell position on a long trade.

Currency shorting example: how to short the pound with CFDs

As an example of shorting a currency using a CFD, let’s suppose that GBP/USD is currently trading at $1.289, with a buy price of $1.2891 and a sell price of $1.2889. You think that the price of this pair will fall, and so open a short position for the sell price of $1.2889.

The size of a CFD position is measured in contracts, and each contract is equal to a single lot of the base currency in the pair – meaning that the price movements of a CFD mirrors the price movement of the underlying asset.

When trading forex with a CFD, a standard contract is worth £100,000 while a mini contract is worth £10,000. Because of this, if you wanted to take out five standard CFDs at the sell price of $1.2889, the total size of your position would be $644,450 ($1.2889 multiplied by 100,000, multiplied by five).

However, because CFDs are leveraged you don’t have to pay the full value of your position upfront. On GBP/USD, the margin factor is 3.33%, which means you only need to put up $21,460 in order to get the full exposure of your position.

In this case, you would realise a profit if the price of GBP/USD fell after you had opened your short position. For example, if the quote price fell to $1.2879, you would have been right in your predictions and the full size of your position would now be worth $643,950 – or a $500 profit.

You should remember, that while leverage has the potential to amplify your profit, it can also magnify your losses as any profit or loss is based on the full size of the position, rather than the deposit amount.

Currency shorting example: how to short the dollar with a spread bet

Now let’s look at how you would short the dollar with a spread bet. In this example, we’ll use the USD/JPY pair – because when you are shorting a forex pair, you are betting that the price of the base currency will depreciate relative to the quote.

Let’s suppose that this pair is currently trading at ¥110.95, with a buy price of ¥110.97 and a sell price of ¥110.93. If you expected USD/JPY to fall in value, you would open a sell position at ¥110.93. With spread bets, you select a per point of movement to determine the size of your position.

As a result, you could bet £5 per point of downward movement from the ¥110.93 starting point of your short trade. The total size of your position can be calculated by multiplying the starting price of your trade in points by the number of pounds per point.

As the yen is the quote currency in this pair, points are measured at the second decimal place, so you would multiply 11,093 by £5 to give a total market exposure of £55,465. You can check how points are measured for your chosen market on IG’s deal ticket.

Since spread bets can be opened with leverage, you would only need to front the margin factor for your chosen forex pair. The current margin factor on USD/JPY is 3.33%, which means that the size of your deposit would be £1847 (3.33% of £55,465).

If you are correct and the price of the USD/JPY falls to ¥110.85 then there has been a movement of eight points. In this case, to calculate your profit, you would multiply the total movement by the amount of money you had placed per point of movement – or £40 (£5 per point of movement multiplied by eight points of movement).

What moves forex prices?

Before you short a currency, you should have a strong understanding of the factors that influence forex rates. Foreign exchange movements are determined by anticipated and actual central bank monetary policy, fiscal policy, interest rates, international trade, macroeconomic statistics, and external factors such as trade wars, conflict etc.

Supply and demand

Exchange rates for freely floating currencies are based on supply and demand of one currency versus another. The exchange rate between two currencies, called a currency pair, shifts due to changes in supply and demand. In basic terms, if demand for one currency is greater than another then the price of that currency will rise against the other.

Central bank monetary policy

Foreign exchange movements are to a large degree determined by anticipated and actual central bank monetary policy, such as the rising and lowering of interest rates, exchange regime settings (a way a monetary authority of a country manages its currency versus other currencies) and, on rare occasions, currency intervention.

Fiscal policy

Fiscal policy - how governments manipulate the levels and allocations of taxes and government spending to promote a stable economy with strong and sustainable growth - also impacts foreign exchange movements. The currency of a country with, for example, a high debt ratio and low growth is likely to be sold by FX traders who instead prefer to buy a currency of a country with low debt and high growth.

Interest rates and carry trades

One of the most popular investments among institutional investors is based on interest rate differentials between countries and is called a carry trade. It involves selling a currency with a low interest rate, with the aim of using the proceeds to fund the purchase of a currency with a higher interest rate. Traders using this strategy attempt to capture the difference between the rates (also called yields), which can often be substantial, depending on the amount of leverage used.

International trade

Anticipated and actual international trade between countries will also influence their foreign exchange rates as a country’s currency with a trade deficit might be worth less than that with a trade surplus, for example. This is to say that a country with a trade deficit imports more goods and services than it exports and therefore needs to buy the currencies of its trading partners to pay for these imports.

Macroeconomic statistics

Forecast and actual macroeconomic statistics, such as inflation, growth and government debt also influence foreign exchange movements. Forex traders and investors therefore analyse data such as Consumer Price Inflation (CPI), Producer Price Inflation (PPI) and Retail Price Inflation (RPI), interest rates as well as the Gross domestic product (GDP), national income, employment and economic growth rates of different countries, for example, before speculating on their currencies.

External factors

Trade and actual wars between countries will also have an impact on whether investors wish to hold these currencies, as wars can lead to infrastructure destruction, increased government debt, shortages of goods and services and even sanctions.

Shorting currencies summed up

• Going short means that you are betting against the market
• You can go short with financial derivatives such as CFDs and spread betting
• By using these financial derivatives, you don’t actually own any currency – but you can still profit from a forex pair’s price movements
• Betting against the market carries unique risks because your losses (in theory) could be unlimited if an asset’s price continues to rise
• As a result, it is important to use stops and limits to mitigate your exposure to risk