The usual way of making a profit in financial markets has long been this: you buy a stock, wait for its price to rise and sell it later at a higher price. Your profit would be the difference between your buying and selling price. However, did you know that you can also make a profit when prices fall? Short-selling refers to the practice of borrowing financial instruments from your broker and selling them at the current market price, with the anticipation of lower prices in the future.

The trader would make a profit equal to the difference of the selling price when prices are higher and the buying price when prices are lower. If the analysis is correct, a trader can make money both in bull markets and bear markets, which is the main advantage of short-selling. The price of an instrument can only fall to zero, but the upside potential is basically unlimited.

Short-selling is different. On the other hand, risks are theoretically unlimited as the price can skyrocket. This is the main reason why beginner traders hesitate to short in the financial markets. Having strict risk management rules in place is a must when short-selling the market.

There are eight major currencies on the Forex market which are heavily traded on a daily basis.

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However, to trade on the Forex market, traders are dealing with currency pairs and not with individual currencies, because the price of each currency is quoted in terms of a counter-currency. The first currency in a currency pair is called the base currency and the second currency is called the counter-currency.

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A rising exchange rate signals any of the following scenarios:. Read those four points as many times as needed until you fully understand this concept. You need to know what is going on with the base and counter-currencies of a pair when short-selling on the Forex market. Currency indices can do a great job in determining what currency is appreciating and what is depreciating. For example, take a look at the Dollar index DXY , which shows the value of the US dollar relative to a basket of six major currencies which have the largest share in the US trade balance.

The following chart shows the US dollar index on the daily timeframe. A bullish candle shows that the US dollar was outperforming most other major currencies that day, while a bearish candle shows a relatively weak greenback. Finally, currency pairs are usually traded in lots. One lot represents , units of the base currency. Shorting on Forex is perfectly possible and many traders do it on a regular basis. Unlike on the stock market, risks associated with shorting on Forex are relatively limited because of the inter-relation of currencies in a currency pair.

“Long” and “Short” Trades Explained

For an exchange rate to go through the roof, there needs to be dramatic changes in the current market environment. Similarly, the downside potential of an exchange rate is also limited. However, Black Swan events unexpected events with severe and long-lasting impact do happen from time to time on the Forex market and are a nightmare for traders. This led to dramatic losses to many market participants who were short on the franc.

CFTC Positioning Report: JPY net shorts climbed further

Another good example is the Brexit vote in When shorting on the Forex market, you also need to be aware of the rollover and financing costs which can decrease your potential profits. That said, you will earn interest payments on the funding currency. How to determine which currencies to short and which not to? As you already know, the best currencies to short are those which have the highest chance of losing value in the coming period.

How to short forex: EUR/USD short selling example

Currency pairs that have formed reversal chart patterns on the daily chart during uptrends could be good candidates to short. Popular reversal chart patterns include:. You can also short currency pairs that have formed continuation chart patterns during downtrends, such as bearish wedges and triangle and rectangle breakouts to the downside. Fibonacci levels also offer an excellent opportunity to enter into a short position if the price rejects an important Fib level, signalling that a downtrend is about to continue. Rejections of the Some traders like to use fundamental analysis to find good candidates for shorting.

Currencies that have a high chance of a rate cut for example, because of weak economic growth, rising unemployment levels or weak inflation are good to short-sell. Capital flows to currencies which have the highest interest rates, causing low-yielding currencies to depreciate and high-yielding currencies to appreciate. Finally, political and economic turmoil, especially in emerging market countries, often cause a depreciation of the domestic currency.

Despite being the largest, most liquid and most traded market in the world, there are times at which you should stand on the sidelines. The Forex market is an over-the-counter market that trades during trading sessions, which are basically large financial centres where the majority of the daily Forex transactions take place. Recently, Singapore and Hong Kong have also become big players in the currency market. The New York session, also called the US session, is a heavily traded session during which major US economic reports are published.

After the London session, the New York session is the most liquid of all Forex trading sessions with a high number of buyers and sellers available for all major currencies. The London session is the largest European session and the most liquid trading session of all. The geographic location of London, being in between east and west, allows traders from both the US and Asia to trade during the London open market hours. The few hours during which the New York and the London sessions overlap represent the most-liquid and most-traded hours of all.

Asian currencies, such as the Japanese yen, Australian dollar, and New Zealand dollar are heavily traded during those sessions. Going short in the forex market follows the same general principle—you're betting that a currency will fall in value, and if it does, you make money—but it's a bit more complicated.

That's because currencies are always paired: Every forex transaction involves a short position in one currency and a long position a bet that the value will rise in the other currency. Another 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. All currency pairs have a base currency and a quote currency. The base currency comes first in the currency pair, and the quote currency comes second.

Changes in price are measured in pips. For every currency but the Japanese yen , a pip is 0.

When the yen is the quote currency, a pip is 0. Brokers will sometimes give values out to one digit past the pip—one-tenth of a pip or a pipette. Many currency transactions are carried out in the standard lot of , units of the base currency. They can also be done in mini lots of 10, units or micro-lots of 1, units.

If you expect the value of the pound to fall against the dollar, you will sell the currency pair at that rate. If you bought the pair after the rate went to 1. The math to find the value of a pip in the quote currency for a standard lot of the base currency is 0. If you're thinking about shorting a currency pair, you must keep risk in mind—in particular, the difference in risk between "going long" and "going short.

While that bet would be bad for your investment portfolio, your loss would be limited, because the value of currency can't go lower than zero. 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.

Long and Short Forex Trades

One way of curtailing your risk is to put in stop-loss or limit orders on your short. A stop-loss order 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.