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What is Short Selling?

FX Scouts By Jeffrey Cammack Updated: September 24, 2019

In CFD trading, it is possible to profit from the falling prices of an asset (like a currency pair) through short selling.

In a short position, a trader initiates a trade by selling a currency pair in anticipation of a price drop. If the price of the currency pair declines as expected, the trader can close the position by performing a buy action. This buy action can be done by either manually closing the position, or it can be done automatically with a preset like a take profit order. A profitable short position is typically closed at a lower price than which it was opened.

The Mechanics of a Short Trade Explained

To understand short selling better, let’s first examine what happens when a long (buy) trade is placed. If you buy the EUR/USD currency pair, you actually buy the euro (the base currency) and simultaneously sell the U.S. dollar (the quote currency).

If the price moves higher after you’ve opened the trade, you can close this long (buy) position by selling the pair at a higher price. In this case, you will have made a profit.

With a short (sell) trade, the process is exactly the other way around. If you sell the EUR/USD, you are buying the U.S. dollar (the quote currency) and at the same time, you are selling the euro (base currency). If the price moves lower after you’ve opened your short trade, you can close this short (sell) position by buying back the pair at a lower price.

In this case, you will have made a profit. In effect, a short (sell) trade on the EUR/USD is exactly the same as a long (buy) trade on the USD/EUR because the euro is sold while the U.S. dollar is bought.

However, on your Forex trading platform, this currency pair is only quoted as the EUR/USD which means that there isn’t an option to place a long (buy) trade on the USD/EUR. So, to buy the U.S. dollar against the euro, your only option is to enter a short (sell) trade on the EUR/USD.

By only using one form (e.g. the EUR/USD) to combine two currencies in a pair, the process of analysing and trading currencies is simplified and streamlined. If every pair had two forms, traders would have to deal with different price quotes, pip value calculations, and charts.

For example, if the EUR/USD traded at 1.11111 dollars per euro, the USD/EUR would be quoted at 0.90000 euro per dollar.

Handy tip: Any trade action (buy or sell) is focussed on the base currency of a currency pair. The base currency is the first currency in any pair. For example, if you open a long (buy) trade on the EUR/USD, you are buying the euro which is the first currency in this pair. If you open a short (sell) position on the EUR/USD, you are selling the euro.

Short Sell Trade – Example

In this example, a bearish trend is observed on the USD/ZAR currency pair. After a decent move lower, a short entry is taken as the price retraces against the predominant downtrend. Soon after the short trade is placed, there is a resumption of the bearish trend and the short position moves deep into profit.

short selling zar fx

At which Prices is a Short Trade opened (Bid) and closed (Ask)?

A short (sell) trade which is executed with a market order will be filled at the best (highest) bid price which is available at that moment. When a short trade is liquidated, it is closed at the lowest ask price which is available at that moment. To see how the bid and ask prices are plotted on a Forex chart, take a look at our guide to Forex trading for beginners.

Conclusion

Unlike a short stock CFD trade, that theoretically carries unlimited risk, short selling a currency pair carries exactly the same risk as buying it. In essence, the mechanics of long and short currency trades are the same. The only difference is direction: a short position will profit when the price declines, while a long position profits when the price moves higher.

Trading Forex and CFDs is not suitable for all investors and comes with a high risk of losing money rapidly due to leverage. 75-90% of retail investors lose money trading these products. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.