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Going short or short selling is among the common strategies in financial markets. Theoretically, investors and traders may short any investment products, but many of them prefer to open a short position of currencies, typically the US dollar (USD) which dominates the vast majority of transactions. The article will elaborate on popular ways to short a dollar and some important factors you should ponder before venturing into this realm.
Overview on Short Selling
Understanding Short Selling
Many people often mix going short up with pure selling. The latter refers to the act of vending what you already own for profits or swap with something else. Meanwhile, when you short something, for example, some dollars, this means you borrow these amounts from banks or brokerages to swap with other currencies or products over a determined period. At the maturity date, the transaction will be reversed and you have to pay what you borrowed in the first place, possibly together with interest.
Without your noticing, short selling is commonplace in every corner of the world. It typically takes place when entrepreneurs use debts to start up their businesses or when households employ loans to purchase properties or automobiles. Different from pure selling, they borrow those chunks from credit unions and pledge to return them at a predefined date in the future. These financial institutions, in turn, receive both principal and interest amounts when the loans expire.
The same also applies to financial markets. When you go short on a dollar, you sell to enter a trade and then re-buy the asset to close the position. To conduct a short sale, you often need to open a margin account with an online broker who enables you to augment your dealing power with hopes of substantial returns. All the process of shorting occurs on the brokerage’s server-side, whereas you may track price movements on the client terminal of the trading platform. Irrespective of investment products or trading style, you should factor in such fees as interest payables, dividends or commissions that can be charged after each transaction.
Pros and Cons of Short Selling
So far, short selling has been an advanced strategy widely utilized by professional and seasoned investors and traders for different purposes although their ultimate goal is always monetary benefits.
Admittedly, traders regard short selling as a means of speculation. They bet on a decline in the selected asset’s value so that they can buy it at a lower cost later, contrary to long-term investors who hold the instrument and expect its price to appreciate for profits.
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Hedging is a justification for investors to short an asset on the ground of its lower risk level and longer time horizon. Accordingly, when realizing the downward trajectory of any instrument over a certain period, investors will open a short position to avoid the downside risk of its long position. This measure is seen to protect their expected financial gains and foil further losses when the bearish market shows no signal to stop.
On the flip side, this tactic is discouraged for novices due to its boundless risks. Indeed, the introduction of online trading platforms and leverage gives more individuals ease of access to financial markets. But very few people make effective use of the borrowed assets or acquire sufficient experience to deal with the heavy tolls of the markets. Besides, the costs of short selling are too exorbitant for the inexperienced to undertake this strategy, regardless of their aims. What if the market continues to move higher and shows more positive signs for long position holders? Consequently, massive failure confronted by short counterparts is unavoidable.
Short selling is not an illegal practice yet prohibited in some jurisdictions as their governments believe that it triggers enormous uncertainties and skews the asset’s price. Some European countries such as Italy or Spain restricted short selling as a result of market stability. The United States temporarily imposed a ban on this activity after a series of unexpected events resulting in the Great Depression during the 1930s, but then immediately enacted the uptick rule in 1938 to buffer the adverse impacts of this activity.
Ideal Time to Short Sell
To increase the odds of the success of short sale transactions, you should enter the market during the bearish trend or when market fundamentals are collapsing rather than in anticipation of downward signs. In other words, short selling is encouraged when the currency or stock market is predominantly awash with weaker data that may be an outcome of long-lasting economic downturn, geopolitical challenges, modest growth or smaller revenues than estimated and other criteria.
Normally, veterans will wait for the market’s plummet to be confirmed as a dominant move instead of rushing to the market when the falling trend sprouts. This is because the market is frequently unprecedented and even financial experts struggle to predict how long the current trend lasts. In early October 2020, Goldman Sachs strategists advised investors to short the greenback relative to a basket of six major currencies in face of the upturn of European activities. However, they promptly waved a white flag on this recommendation when witnessing the astonishing growth of this reverse currency and typically its index, DXY.
Therefore, when no hint guarantees the continuous decrease of the asset’s value, shorting the asset is nothing short of a high-risk venture that may expose you to an unprofitable situation.
How Do You Short a Dollar?
Historically, the financial world saw the dollar lose its momentum at times but surprisingly recover its status. This makes the currency become one of the safe havens that investors may purchase during the economic slowdown. Having said that, professionals advise against a long position of the greenback when it is weakened relative to other currencies or better-quality assets. Here are some common ways to open a short position in such a time:
Trading in the foreign exchange market is the most preferred method to obtain short exposure to a dollar because of fewer stringent policies. This gives traders easy entry to the decentralized market, however low their capital is. Not to mention that the retail market now empowers participants to trade without holding the physical instrument. In other words, traders are not required to borrow a tradable instrument or at least show evidence that they are capable of borrowing it. This is commonly known as “naked short selling”. This activity is banned in some countries owing to its higher stakes, but also comes with respective rewards.
Besides, the settlement period of a conventional short sell commonly covers two business days which are deemed adequate for the delivery and receipt of traded currencies. Nonetheless, the coming of naked short selling shortens the trading time and allows traders to conduct multiple trades even within a trading day.
It is difficult to decide which currencies to long if you short a dollar. Traders are highly recommended to track technical indicators thoroughly and reference the analytical reports of experts to see which major peers are outperforming the US dollar. Additionally, you may weigh up a basket of powerful currencies when the DXY continues extending its decline.
Investing in ETFs and Mutual Funds
Those who revel in a safer solution may look to the following currency exchange-traded fund (ETF) and mutual funds. Beyond that, investors are encouraged to use technical tools to seek good investment opportunities.
- Invesco DB U.S. Dollar Index Bearish Fund (UDN)
This fund compares how the dollar’s value changes relative to six prime currencies including the Euro (EUR), Japanese yen (JPY), British sterling (GBP), Canadian dollar (CAD), Swiss franc (CHF) and Swedish krona (SEK). UDN allocates a significant portion (57.7%) of its portfolio to EUR.
- Invesco CurrencyShares Euro Currency Trust (FXE)
FXE holds prodigious quantities of physical euros to participate in short positions of the EUR/USD. So little wonder that its liquidity is substantial with a daily number of stocks reaching 200,000 shares. One possible downside is that no insurance covers its physical funds of euros, thus investors are prone to default risk.
- ProFunds Falling US Dollar Fund (FDPIX)
Likewise UDN, the FDPIX mutual fund follows the volatility of the US dollar compared to six trading peers engaged in the ICE US Dollar Index (USDX). Deposits will be used to invest in foreign debt securities, so investors should pay attention to related risks before putting their cash into the fund.
Longing Good Assets
Opening a foreign exchange account and pouring savings into ETFs or mutual funds are not the only ways to make a short sale of dollars. Economists suggest investors and traders turn their focus on other good assets that increase their net worth more than their holding of the greenback.
Robert Kiyosaki, a founder of Rich Global LLC and Rich Dad Company, believed that using debts to purchase real estate was a sensible decision, whilst Warren Buffett’s investment principles lay in S&P 500 index, company acquisition, and stocks. No one is wrong because reality has cited their achievements and growing wealth despite their different mottos.
Apart from considering the fluctuations of the US dollar in value against those assets, it is equally essential to count the inflation rate and interest rate related to your investment. Regularly, many people short the dollar to buy assets to eliminate the profound influence of inflation that refers to the decrease in the buying power of the currency. However, the rising inflation rate will lead to the release of a higher interest rate, which increases the total payable involving the principal and interest amounts. Therefore, your borrowed dollars should come with a fixed interest rate that is lower than an inflation rate before being used for any investment.
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