The Basics of Short Selling Currency
For individuals on the outskirts of the Forex world, the practice of short selling currency can seem excessively complex. However, while analyzing the markets and timing trades is something best left to seasoned professionals who use a range of advanced technologies and tools, understanding the basics does not require a graduate degree in finance. According to Isaac Gilinski, the owner of Brickell Analytics which provides customized macro-based research on global markets, here are the fundamentals:
Understanding Relative Currency Values
Like stocks, currencies rise and fall in value — not due to inherent value, but due to relative value in comparison to other currencies. For example, a U.S. one-dollar bill is worth the same today as it was 10 years ago and will be 10 years from now: a dollar. Naturally, the purchasing power of a dollar will change over time and will fall due to inflation (countries that experience a negative inflation rate — called deflation — see the purchasing power of their currency rise over time; this hasn’t happened in the U.S. since the Great Depression in 1930-1933). Yet, the basic point remains: a U.S. dollar has always been, and always will be, worth a U.S. dollar.
However, the situation is quite different when we look at relative currency values, because these can and do change all the time. Isaac Gilinski claims that anyone heading out on a cross-border vacation or business trip has experienced this when visited their bank (or any other source) to exchange currency into a foreign denomination, or if they used their credit card while abroad. The amount they need to purchase or sell foreign currency can change from minute to minute.
Understanding Currency Short Selling
In light of the above, currency short selling is the practice predicting that a currency will fall in value relative to another currency (betting that a currency will rise in value relative to another currency is aptly called long selling or taking a long position). This is why currency quotes are always paired in a two-sided transaction, such as EUD/USD or USD/JPY. The pairing implies that a trade does not involve just selling one currency: it also involves buying the other currency. This is also why it is not necessary to borrow money to take a short position, and why investors can sell currencies that they do not technically own.
If a currency does indeed fall in relative value — that is, if it becomes cheaper to buy the currency after it has already been sold — then investors who have taken a short position potentially generate a profit (the maximum profit potential is 100 percent assuming no leverage and borrowed money). Adds Isaac Gilinski: “Investors do not necessarily have to close their full position. They can close part of their position and keep the rest open in the trade if they believe further profits are likely.”
“While it’s fine to admire the exploits of investors like Soros, most new investors should start small and stay within their risk tolerance. If they do, they may discover that short selling currency is quite rewarding — and indeed, very interesting!”
Can Short Selling Lead to Big Profits?
While short selling — like all other kinds of investing — involves risk and there are many variables to take into consideration, it can indeed lead to big profits. For example, in 1992 George Soros took a short position on the British Pound (GBP), after he speculated that the British government could not afford to continue propping up the Pound relative to other currencies such as the German Mark (DEM). Once Soros’ prediction became reality, he pocketed a cool $1 billion (USD). Isaac Gilinski’s firm Brickell Analytics has also hit several short selling home runs. For example, in April 2013 after using various techniques such as sentiment analysis and pattern identification to predict reversal points and trend changes, Brickell Analytics correctly predicted a 20% drop in the AUD/USD exchange rate. While it’s fine to admire the exploits of investors like Soros, most new investors should start small and stay within their risk tolerance. If they do, they may discover that short selling currency is quite rewarding — and indeed, very interesting!
To learn more about Isaac’s prediction of the Aussie Dollar Decline click here.
Author Disclaimer: The views, thoughts, and opinions in this article belong solely to the author, and do not necessarily reflect those of Isaac Gilinski, Brickell Analytics or George Soros. Furthermore, the prediction made by Brickell Analytics was one of many predictions made by Brickell Analytics; not all predictions are accurate. Brickell Analytics does not provide any personalized investment advice, nor does it engage in trading of securities. This article should not be considered investment advice or an offer to sell or the solicitation of an offer to buy any securities. Soros and Brickell Analytics are not related parties, and Soros makes its own investment decisions. Neither the author nor Brickell Analytics can verify any profits or losses made by Soros. All profits are for illustrative purposes and are not a suggestion that similar or future profits may occur. Past results are not necessarily indicative of future results. All investments involve risk and potential loss of principal. It should not be assumed that future investors will experience returns comparable to those of the research discussed herein.