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Sell High, Buy Low: Short-Selling Basics

by on January 23, 2014 5:47 pm GMT
 

As a new trader begins their journey in trading, they are typically buy-side biased. Even to the non-trader, the fundamental principle of “buy low, sell high” is ingrained into memory. New traders sometimes limit their potential from not understanding how to profit from down moves or risk a trade buy always being on the buy side.

The currency markets are set up different than other assets; transactions are processed differently. For instance, in order to short-sell a stock, a trader must borrow shares from the brokerage. This can be difficult because the brokerage may not have that stock or enough shares to lend out. In some cases, there are additional charges to short-sell stock.

However, the forex markets allow traders to short-sell with ease. There are no additional fees as the spread is the same whether a currency pair is bought or sold. Traders must also acknowledge that when they buy the USDJPY, they are long the US dollar and short the yen. On the other hand, if a short-sell is placed on the USDJPY then the trader is short the dollar and long the yen. So, short-selling opportunities are beneficial because it allows profit from both up and down movements, but it also allows the ability to short a weaker currency pair against a stronger peg.

If the Sterling and the dollar is down, the trader  could potential go long GBPJPY while shorting USDJPY. This also may hedge a higher long yen basis if the yen is flat.

In order to execute a sell order on the broker’s bid/ask control panel, one would sell on the bid and buy back – hopefully lower – on the ask.

To increase the odds of a short trade, look for strong resistance and support levels. These can act are potential exits and entries. For example, this EURUSD 4H chart shows an example of a short order on confirmed resistance and support for a potential 25 pips.

1D Chart of EURUSD, example short-trade

1D Chart of EURUSD, example short-trade