Currencies, by their very nature, fluctuate constantly in value when compared to other currencies. While this can have all sorts of implications for economic and financial issues, it can also offer an opportunity for shrewd traders and investors to make a profit.
Investing and trading circles are full of jargon and specialist terms, which can work to discourage someone thinking of opening an investment portfolio of their own. One term that is often heard in Forex trading is the idea of ‘betting against’ something. Before we dive into what betting against entails, first we must ask ourselves: what is forex trading?
What is Forex trading?
In its most basic form, Forex trading has existed for nearly as long as international currencies have. Essentially, Forex trading is the process of converting one currency into another to make a profit. It’s a market that is open 24 hours a day and has an estimated daily transaction value of $6.6 trillion. This makes it an extremely appealing prospect for traders and investors, it’s one of the most active markets on the planet.
In Forex trading, currencies are matched in pairs, such as Great British pounds against US dollars (GBP/USD), or US dollars against Japanese yen (USD/JPY). Each pair is given a current quote value, which indicates how much of the quoted currency (the currency on the right) it takes to purchase one unit of the base currency (the currency on the left).
For traders to make a profit, they must be able to accurately predict the movements and fluctuations in these currency values. If a trader thinks a currency is strengthening and will increase in value, they would buy that base currency. If they predict that a currency is about to fall in value, they would sell that base currency.
There are a range of different types of Forex trading. Scalpers will make several trades a day, making an incremental profit through a number of small returns. At the other end of the scale are position traders, they will hold currencies for weeks, months, or even years, taking advantage of long-term trends in the market.
Traders use all sorts of methods to make predictions and estimates about potential currency movements. Paying attention to the news, reaction to the market, and the actions of central banks can allow Forex traders to forecast how certain currencies will behave in both the short and long-term.
If a trader decides to buy a currency, they are in effect betting that this currency is set to perform well in the future. This is also known as ‘going long’. If a trader decides to sell, they are betting against the health of that currency and indicate that they expect the value of that currency to fall, this is known as ‘going short’ or ‘shorting’. Let’s take a look in more detail.
Shorting a currency
When the layman thinks of investing and trading, they could be forgiven for assuming that profits can only be made when the market is healthy and performing well. A volatile, unstable market might not instill feelings of confidence, but it can present unique opportunities for financial returns if the correct steps are taken.
When traders short a currency, they are speculating on that asset’s falling value. They borrow these assets from a firm or broker then sell them at the current market price. If their prediction was correct, the currency’s value will then fall, which is when the trader can buy back assets to return to the broker at a lower price, pocketing the difference.
Let’s use an example that will paint a clearer picture. A trader predicts that the British pound is about to fall in value. She borrows 100 units of that currency and sells them for the market price of £100. At some point, she will need to buy back these assets to return what she borrowed to the broker. If the currency were to increase in value, the trader will have made a loss as shse’ll have to spend more to buy back the same number of assets. However, her prediction was correct, she’s able to buy back 100 units for £80, making a profit of £20 after returning these to the broker. This is known as shorting or betting against the pound.
Betting against a currency is a perfect example of how clever traders who understand the market and can make timely, accurate predictions can make profits even in times of financial instability. While it requires market knowledge, experience, and a level of risk, it has the potential for significant financial returns.
Conclusion
Forex trading is an industry loaded with technical jargon and confusing terminology. If you’re looking to start trading and investing, you need to take the time to inform and educate yourself about common words and phrases you might see being used.
Shorting or betting against a currency is a phrase you’ll see often, especially in times of financial uncertainty, much like we’re seeing now in the UK. Traders who have a solid understanding of the market can make accurate predictions about the movement of a currency and employ methods to ensure they profit from asset fluctuations.