A trader is in a SHORT POSITION when she sells a currency pair.
Longing is the opposite of going short. The trader is in a LONG POSITION when she buys a currency pair.
Short selling (often “selling short”) is a technique used by traders who want to profit as prices fall.
For example, consider an investor who wants to sell short EURUSD, believing the Euro is overpriced, the US Dollar is ready for a rally and EURUSD will fall. If the price of the currency pair drops, she “covers the short position” by buying back the EURUSD. The profit is the difference between the price at which the currency pair was sold and the cost to buy it back, minus the spread and any interest rollover. But if the price of EURUSD increases the position will create a loss.
Brief History of Short Selling
Short selling was illegal in parts of Europe as early as the 1700s due to a number of disastrous speculative bubbles burst at the time. Regulators then, and many still suggest today, that short selling magnifies downside moves in security prices. Though today short sellers are mostly valued for their added liquidity, which may lead to greater market efficiency.
Disadvantages of Short Selling Outside of FX
In the stock market, short selling can potentially lead to unlimited losses for a trader, since share prices many theoretically increase indefinitely – and stock brokers often allow trader’s accounts to build negative balances. For this reason short selling is a very risky technique outside of the Forex market. SEC rules allow stock traders to sell short only on an uptick or a zero-plus tick (an additional cost and delay for the trade), to prevent “pool operators” from driving down a stock price through heavy short-selling, then buying the shares for a large profit.
Such unlimited losses may be avoided in the spot Foreign Exchange market, and there are no ‘uptick’ rules in FX. Also shorting is truely unavoidable in FX. Whenever a position is bought or sold traders are always buying one currency and selling another. If one buys EURUSD – one is shorting US Dollars. If one is selling EURUSD, they are shorting Euros.