How Short Selling Works and How to Take Advantage of It (Part 3)

Risks and Opportunities of Short Selling at Forex

Everything is clear with possibilities - a trader can earn in a short time on falling in price of an asset (currency, security, raw material - shorts are opened with everything). And it is possible to earn really good money if one can accurately predict the strong fall of the price and competently diversify risks. Experienced traders make 2000-4000 dollars per week on shorts, and this is not the limit.

What's the catch? The first point we've already mentioned - a broker does not give credit for free. You have to look at the percentage of the short rate in the plan you choose. For example, it's 13% per annum. That means that you will have to pay $130 per year or 0.36 cents per day for every $1,000. If the position remains open for several days, this is a significant amount. Another important point of shorting on the exchange and Forex is the increased risk due to mathematical expectations. To simplify, when you buy an asset, its price can grow infinitely, so your profit, in the long run, has no limit. And the price of the asset can fall only to zero, and your loss is limited strictly to the amount invested. That is, if you buy a security or other asset for $1,000, you have the opportunity to earn $5,000 or more, but lose only $1,000.

With shorts, it's the opposite - your profit is always strictly limited, but your loss is not. Considering that you trade with credit funds, the broker will not allow you to lose more than you can handle (that's why the margin is calculated with the risk rate), if the trend is unsuccessful, he will take back some or even all of the funds that were frozen in your account as credit security.

The main risk with a short in the stock market is a squeeze. A situation where the trader becomes a hostage to his own actions. For example, he actively buys currency futures, creating demand, and the price of the asset rises. The bears, who bet on a falling price, are not happy, so they open shorts by selling the asset, with the intention of buying it later, when the price falls. If the bears' efforts are not enough and the trend does not change, they have to close positions at the market price in order not to lose more. But they only push the trend higher.

A short squeeze is when there are fewer sell orders, and the price rises sharply. It occurs when bears actively close orders, trying to avoid losses due to an unfavorable trend. No matter how well a trader calculates the economic situation in the world, he or she will not be able to be protected from the squeeze. This risk cannot be avoided.

In the next article, we will tell you about the types of accounts for shorting currencies.

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Follow our updates for useful information in our series of articles. You can also visit our previous article for a better understanding of this topic.