How to short a market and when to go short

What is short selling?

To define short selling, let's focus on the most important aspect: short positions profit from markets falling. Just as long positions profit when a market’s price rises, short positions aim to profit from a market's decline. For example, let's consider the euro versus the U.S. dollar, a popular forex pair. If you believe that the euro will appreciate, and the market will go up from 1.10 towards 1.15 or higher you would buy the euro or go long. Conversely, if you anticipate the euro will decline to 1.05, a dollar even, or below parity, you would short it and profit from lower prices. It's important to note that if the market moves in the opposite direction, you will experience losses. Essentially, short selling has the opposite payout structure from buying a market or going long.

How do you short different markets?

Now that we understand the concept, let's delve into the basics of short selling in different markets.

Stocks

Short selling in the stock market, such as Apple or the S&P 500, can be more complex and potentially costly compared to short selling in the Forex market. Brokerages may require margin accounts to short stocks and most require 100% margin or even more, meaning you need to put up the full value of the stock or even a higher amount as collateral. Additionally, you may have to pay interest on the borrowed shares since the brokerage, as a lender, is maintaining the exposure for you. These costs can add up and impact your overall profitability. However, the principles of short selling remain the same for shorting stocks - traders profit if the stock price drops and experience losses if the share price rises.

Derivatives

Options and futures trading have similarities to short selling stocks. Options are derivative tools that allow you to trade on various markets, including stocks, ETFs, commodities, and foreign exchange pairs. Options trading provides several ways to gain short exposure including selling calls and buying put options. These strategies can be beneficial for short-term traders preferring defined risks. Trading options can involve margins between 20% and 100% of the market value, and they may come with commissions. Futures, on the other hand, have variable margins that change with market volatility. Forex futures, similar to forex trading, tend to have lower margins due to their relatively stable price movements. While options and futures may not have interest charges, they may have commissions or other associated costs.

Spot forex

Forex trading provides a slightly more dynamic logic in short selling. By shorting or selling a forex pair, you are actually going long one currency while shorting the other simultaneously. By this logic, even going long in forex has an element of going short. Take GBP/USD for example - buying the pair would mean going long British pound while shorting US dollar. Conversely, shorting GBP/USD means you believe USD will appreciate against GBP - and the pair price will decrease.

Shorting forex pairs can be done with low margins, starting from just 2%. Additionally, trading forex with tastyfx means zero commissions*, with the bid-ask spread the only cost to execute a trade.

Find out more about forex costs

*tastyfx US does not charge commissions, your cost is the bid-ask spread to execute a trade. tastyfx US is compensated through an intragroup hedging arrangement with its affiliate, tastyfx Markets Ltd.

How do you open a short trade?

When it comes to executing a short trade, most trading platforms make it as simple as selling a product, just like you would buy it. However, instead of closing a long position, you enter the market with no position and click the sell button. To close out a short position, it can be as easy as clicking the buy button. It's crucial to monitor your position size, risk, margin requirements, and associated costs.

When to go short

Now, let's discuss when you should consider going short. Interestingly, the strategies for going short are often similar to those for going long. Just as you would buy something because it's cheap or you believe it will soon fetch a higher price, the same logic in reverse could apply when going short.

Technical analysis

Technical analysis tools can provide traders with just as much insight into when to sell as when to buy. Momentum indicators such as the relative strength indicator (RSI) stochastic oscillators can help identify overbought or overvalued markets that may be ripe for a short trade. Moving averages and volatility indicators may also signal when a pair is trading higher than usual - a potential time to sell. Lastly, tastyfx client sentiment shows what percentage of traders are long or short in any given pair. Traders often use those percentages to choose whether join the majority or take a contrarian stance.

What are the best chart indicators?

Fundamental analysis

Traders can also employ fundamental analysis to decide when to short forex pairs. This requires monitoring the release of economic data or monetary policy changes. If you anticipate a data release will result in a currency’s depreciation, you can short that currency in anticipation of a fall in price. Monitoring global interest rates can also help traders identify potential carry trades. If a quote currency (base/quote) has higher interest rates than the base currency, it is likely that traders could receive a credit for holding a short position overnight.

Beginners guide to the carry trade

Risks of short selling

Going short is not without risk. Opposite of going long, traders are exposed to potential losses when the price of a forex pair rises. One such scenario is a short-squeeze. This trend occurs most frequently in stock trading and happens when the price of the stock rises rapidly - causing other short sellers borrowing stock to close out of their positions. As a result of the additional short sale, the asset could appreciate even further. Short-squeezes are less common in forex markets due to the increased liquidity, making it more difficult for the actions of other traders to influence the price.

Short selling exposes you to unlimited losses if the market moves against your position. To mitigate this effect, many traders employ risk management strategies such as stop-loss orders. Additionally, when margin trading, margin calls and interest charges can impact your capital.

In conclusion, short selling is a concept that allows investors to profit from markets falling. By selling a market that you don't own, you can potentially benefit from price declines. Short selling strategies can be applied across different markets, including stocks, options, futures, and forex. Shorting markets can also be applied to various investment strategies, from long-term investing to day trading. However, it's crucial to understand the specific requirements, costs, and risks associated with each market. By applying the same strategies and tools used for going long, you can identify potential short opportunities.

Practice trading forex using indicators

1. Open an account to get started, or practice on a demo account
2. Choose your forex trading platform
3. Monitor pairs using different chart indicators
4. Open and close positions on forex pairs

Trading forex requires an account with a forex provider like tastyfx. Many traders watch major forex pairs like EUR/USD and USD/JPY, which can be found in tastyfx's platform under the 'Major' pairs tab, for potential opportunities based on economic events such as inflation releases or interest rate decisions. Economic events can produce more volatility for forex pairs, which can mean greater potential profits and losses as risks can increase at these times.

You can help develop your forex trading strategies using resources like tastyfx’s YouTube channel. Our curated playlists can help you stay up to date on current markets and understanding key terms. Once your strategy is developed, you can follow the above steps to opening an account and getting started trading forex.

Your profit or loss is calculated according to your full position size. Leverage will magnify both your profits and losses. It’s important to manage your risks carefully as losses can exceed your deposit. Ensure you understand the risks and benefits associated with trading leveraged products before you start trading with them. Trade using money you’re comfortable losing.