In all financial markets like Forex, you sell short when you believe the value of what you’re trading will fall. With a stock, what you’re doing is selling borrowed shares you don’t actually own. In addition, you agree to return those shares at some time in the future.
The same general principle is going short in the forex market. You’re betting that a currency will fall in value, and if it does, you make money. But, it is more complicated.
Placing a Sell Order
The difference between shorting in the stock market and the forex market is that in the latter.
You don’t have to borrow a certain amount of the currency you want to short. Going short in forex is as simple as placing a sell order.
Parts of the Pair
All currency pairs have a base currency and a quote currency. For instance, the GBP/USD pair, the British pound is the base currency and the U.S. dollar is the quote currency.
Pip Values
Changes in price are measured in pips. But, there is an exception for the Japanese yen, a pip is 0.0001 of the value of the quote currency. When the yen is the quote currency, a pip is 0.01 yen. (Brokers will sometimes give values out to one digit past the pip—one-tenth of a pip or a pipette.)
Lot Sizes
The standard lot of 100,000 units of the base currency. They can also be done in mini lots of 10,000 units or micro-lots of 1,000 units.
Let’s say the GBP/USD rate is 1.3452, which means 1 pound is valued at $1.3452. If you expect the value of the pound to fall against the dollar, you would sell the currency pair at that rate. If you bought the pair after the rate went to 1.3441, you would have made 11 pips.
The calculation to find the value of a pip in the quote currency or a standard lot of the base currency is 0.0001 (one pip) / 1.3452 (exchange rate of pair) x 100,000 (lot size) = $7.43.
That means for your 11-pip gain, you would have made 11 x $7.43 = $81.73, excluding the commission.
Reducing Risk
If you’re shorting a currency, on the other hand, you’re betting that it will fall when, in fact, the value could rise and keep rising. Theoretically, there’s no limit to how far the value could rise and, consequently, there’s no limit to how much money you could lose.
To curtail your risk is to put in stop-loss or limit orders on your short. It orders simply instructs your broker to close out your position if the currency you’re shorting rises to a certain value, protecting you from further loss.
A limit order, on the other hand, instructs your broker to close out your short position when the currency you’re shorting falls to a value you designate, thus locking in your profit and eliminating future risk.
