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How to Short Sell in the Currency Markets
Books on Short Selling
There are numerous reasons why investors are uncomfortable with short selling. One powerful motive is because it is counter intuitive. It makes more sense and is far more logical for people to buy an asset, either tangible or intangible, keep it for a while, and then sell it at a price which is higher than the price you bought it. You buy a bond or a stock for $99, hold onto it for several months, and then sell it for $102, making a nice little profit. Let's take an example, you buy a house, you live in it, and the value of the house increases, so then you sell it to buy another house. You can buy another house for investment, you can rent it out to help pay for the mortgage on the property. You don't live there, but you still own the house. In all of these examples, you buy an asset, you own it, and then you sell the asset at a higher price.
However, and this is the rub, in short selling, you are selling something that you don't even own. I know that this sounds counter intuitive because you can't go around to your neighbour and sell something of his which you don’t own. Hence, short selling does not make a lot of sense to many people. The next example will ease you slowly into the notion of short selling.
Imagine that the shops have just closed and you suddenly remember that you need a loaf of bread to feed your dinner guests. You go over to your neighbour’s and ask to borrow a loaf of bread. Your neighbour has just bought a loaf of bread for $4, but she refuses the money you offer. Instead, she tells you to buy her another loaf of bread later, and you will be quits. The next day, you go to the supermarket and the loaf of bread is on sale for $2. You buy the loaf of bread and return it to your neighbour and save yourself $2 in the course of the transaction. In essence, you ate the bread, which is an asset that isn't own by you, and then you delivered an identical asset (bread) back to your neighbour at a later time. This then is the theory of short selling. A short sale is the sale of a security or an asset that isn't owned by the seller, but that is promised to be delivered.
Say for example you don't think that Microsoft’s share price should be at $140 per share because the company is not doing so well. You can borrow 10 shares from your stockbroker, and sell them for a gain of $1,400. When the stock price drops to $80, you buy back the 10 Microsoft shares at $800, and return them to your broker. You borrowed 10 shares from your broker, and then you returned 10 shares, pocketing $600 in the process. If the price of the stock rises, though, you have to buy it back at a higher price, and you would lose money.
In currency trading, you can make money when a currency pair is either up or down, if you are able to foresee the up and down trends in the market. If you think that the currency pair is going up, you buy at the low price and then sell at a higher price. Alternatively, if you believe that the currency pair is going down, you can sell at the higher price and then buy back at a lower price to recover. In real time currency trading, the currency rates are changing by the second. For example last Friday the Euro/Dollar currency pair at 11.05am was 1.3367, at 11.06 it was 1.3360 and at 11.07 it was 1.3376. If you had sold Euro at 1.3367 and bought it back at 1.3360 one minute later, you would have made 7 pips or $7 per $1,000 sold and bought. However, you could also have bought Euro at 1.3367 and sold them when the rate was 1.3376 two minutes later and made 9 pips profit.
In the stock market a bull market can last as long as several years; hence, it is difficult to switch your thinking from a bull, an upward trending market, to a bear market, a downward trending market. Currency markets however can have a bullish and a bearish period within a short space of time such as a day or even within an hour. Even though you have the tools for short selling and long buying to in the foreign currency market, currency trading is not easy to master and more than 90% of traders lose their money. The best and less risky way to start currency trading is to sign up with an online forex trading system where you can take advantage of leverages of 400 to 1 and don’t need to open an account with a lot of capital. What’s more you can practice using a dummy account with real time rates. Check out www.etoro.com or www.FXCM.eu or www.easy-forex.com