In financial markets, like stock trading, it is not uncommon for investors to understand “one-way” trading principles, following “buy low and sell high” principles or believing that profits can only be made when prices rise.
However, one of the characteristics of forex trading is that it can be traded in two directions.
When investors expect the exchange rate of one currency pair to rise, they can buy that based currency, also known as a long position. And if the exchange rate of a pair is expected to fall, they can sell that based currency, also known as a short position.
In other words, no matter if the exchange rates of the currency pairs go up or down, there are profit opportunities.
How do you short trade?
The concept of relative value
Since the forex market deals with currency “pairs”, the so-called short selling is not just related to a single currency, which is slightly different from similar concepts in other markets.
Because a currency pair involves a combination of two assets, any ups or downs in price does not just represent the appreciation or depreciation of a single currency, but a change in the relative value of the two currencies.
When an investor trades a currency pair, such as EUR/USD, and chooses to long the EUR, he goes short against the other one (USD) in effect. By contrast, if he shorts EUR, he longs USD at the same time.
For example, an American holding dollar converting dollars into euros at a bank is essentially selling (going short) his dollars and buying (going long) euros.
Forex margin trading
The question is, if he’s an Australian and doesn’t have dollars, how can he sell dollars and buy euros?
So that’s how margin trading works in the forex market. The basic concept behind is that margin trading allows an investor to deposit a certain amount of money as margin and trade through a broker. The logic is that investors actually “borrow” from the broker in order to sell one currency and buy another currency.
Thus, investors do not have to hold any currency in advance, but can still “trade in both directions” in the forex market, because brokers are willing to provide investors with the “financing” service.
For example, when that Australian investor goes long EUR/USD, he actually borrows dollars from the broker to sell in the market and buys euros. When euro rises, he sells the euro and buys the dollar back to pay off the original outstanding from the broker. Of course, if the euro falls, his loss will be settled in his margin trading account.
But more realistically, margin trading mostly does not involve physical delivery, so there is no need to actually hold any currency.
Participants only hold “forex contracts”, in which buyers and sellers only have to settle the price difference at the end between the opening and closing market price.
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Risk Warning: The above content is for reference only and does not represent ZFX’s position. ZFX does not assume any form of loss caused by any trading operations conducted in accordance with this article. Please be firm in your thinking and do the corresponding risk control.