– Many new people on the Forex / Foreign Exchange market might think “going short” or “shorting” means that holding a pair for a very short amount of time, and “going long” means that holding a pair for a long amount of time. Also, this estimate appears reasonable. But, in fact, “going short” or “shorting” has nothing to do with any amount of time period to do anything.
In the simplest definition, “shorting” means making money when something’s price goes down. We didn’t say pairs or currency here, because “shorting” is not a term exclusive to Forex. Actually, it can apply to the stock market, futures market, options and any other market that you can make money out of a price decrease.
Most new people in financial markets such as forex think that the way to make money is buying low, selling high. In a way, this is true. It is the general way how markets work. However, as you get more advanced in the market and learn more, you will have a way to make money when prices go down too. This is why financial markets like Forex is really impressive. The direction of the movement doesn’t really matter as long as you know what are you doing.
How “Shorting” works?
“Shorting” or in other words, “going short” is actually a bet. Because by “going short” you risk the benefits of any possible upcoming value increases.
Let’s say that you have a prediction for the value of USD (US dollar) against AUD (Australian Dollar) to drop. In this case, for shorting USD, you can sell your USD/AUD pairs in the Forex market before this drop happen.
This way, if your prediction is right, you can avoid the loss and obtain AUD which will be more valuable against USD soon. So, when the drop happens you can buy more USD then you sold with the same amount of AUD. And, this is how you make money with “shorting“.
To put it in exaggerated numbers
Assume that the value of the USD/AUD pair is 1.5, meaning that you can buy 1.5 Australian Dollars with 1 US dollar. If you have 1000 USD to invest and you are expecting a decrease in USD/AUD value, you would want “going short” on USD.
So, you would sell 1000 USD worth of USD/AUD pairs and obtain 1500 AUD. Then if USD/AUD value goes down as you were expecting, let’s say from 1.5 to 1.25, you would want to sell your 1500 AUD for USD back. With this new 1.25 value, you could get your investment back at 1.200 USD. So, the 200 USD here is your shorting profit.
Risks of Shorting in Forex
One of the most common comments you can hear about “shorting” or “going short” is that the potential loss is unlimited. But, how? What does this mean? Why is it riskier than “going long”?
If we explain it with examples again;
Let’s take AUD as our base for this instance.
While going long on AUD, as most traders do, you buy a certain amount of AUD and hold it until it gets more valuable against a currency you want. By selling your AUD when it has a higher value against the currency you want, let’s assume again that it is USD, you would make a profit. But, the risk here is here that the value of AUD against USD might not increase, instead, it can drop. So, you would have a loss in your hands. Technically, AUD/USD only can drop until zero, meaning that the maximum amount of your loss is the amount you invested in the beginning.
Theoretical Risk of Shorting
However, while Shorting (going short) on AUD, you sell your AUD investment expecting that its value will drop. But, if AUD somehow does the opposite and increases its value, you would be missing the opportunity of owning more AUD with its new higher value and you would be stuck with the currency you were planning to buy AUD back with. The problem here is that, while the maximum value decrease can be until zero, there is no limit for the value increase. So, theoretically, the value of AUD can increase unlimitedly and your theoretical loss by selling it before the increase would grow with it unlimitedly.
Of course, this is just a theoretical possibility. As long as you do your research thoroughly and know what you do, shorting or going short is a remarkably effective way to invest in forex.
I wish, you should have grasped the basics of shorting (aka Going Short) on forex market. For more detailed explanations on this topic, you can have a look at the links belong to this website or other related websites, you see on this page.
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