What is short-selling and how does it work?

Edited June 7, 2020

What is short-selling?

Short-selling, also known as ‘shorting’ or going short’, is a trading strategy used to take advantage of markets that are falling in price. The traditional way to short-sell involves selling a borrowed asset in the hope that its price will go down and buying it back later for a profit.

Borrowing the asset comes at a cost, which is normally a small percentage of the asset’s price. However, you can also short-sell using leveraged derivatives, which enable you to speculate on the price movements of an underlying asset without taking ownership of it.

What makes short-selling different is that you would take the position only if you have a negative outlook on an asset’s performance. You most likely believe that there is no potential for price growth, and you think the market is entering a downswing. If you didn’t, you would take a long position. Then there’s hedging; short-selling can also help you to hedge against potential downward movements if you have a long position open.

When you trade with us, you can use derivatives known as rolling spot forex contracts to go long or short on over 80 major, minor and exotic currency pairs – either with the aim of generating a profit or to hedge your existing positions.

How to start shorting

To start shorting forex pairs using derivatives, follow these simple steps:

  1. Open an IG trading account: it only takes a few minutes to open an account. You can even do it on your smartphone
  2. Find an opportunity: we offer various tools, including updated news and trade ideas, to help you find what you’re looking for
  3. Place your trade: when you’re ready to trade, open your first position by selecting the forex pair you want to short and choosing ‘sell’ on the deal ticket

Ready to start short-selling? Open an account with IG.

How does short-selling work?

Short-selling works in two different ways, depending on how you want to trade. Traditional short-selling involves borrowing the underlying asset from a trading broker, immediately selling it at the current market price, and then buying it back at a later date to return to the lender. The alternative way to short sell is to speculate on price movements using leveraged derivatives.

Traditional short-selling comes with a few limitations. For instance, because you don’t own the assets that you are going to trade, you’ll need to find someone that’s willing to lend them to you. The second method – using leveraged derivatives – does not require the exchange of an underlying asset.

When trading with derivatives, you make an agreement with a trading broker to exchange the difference in price of a currency pair between the time the position is opened and when it is closed.

Ready to get started? Practice your trades on a demo account or open a live trading account and take on the markets.

Example of short-selling forex using leveraged derivatives

Suppose GBP/USD is currently trading at 1.2860, but you think the price will go down. So, you decide to open a short position on one mini lot, which is equivalent to 10,000 units of the base currency – in this case pounds. Your total exposure would therefore be $12,860 (£10,000 x 1.2860). However, because you are trading via leverage, you only need to put down 5% of the trade value ($643) to open your position.

Three days later, the price of GBP/USD is 1.2810 and you decide to close your short position. This means you would make $50 in profit ([£10,000 x 1.2860] – [£10,000 x 1.2810]). If the price went up instead, you would have made a loss. For example, if the pair was trading at 1.3010, you would have lost $150 ([£10,000 x 1.2860] – [£10,000 x 1.3010]).

Related Articles

Back to top button