Lots of chat in the UK press today about bankers ‘shorting’ GBP last Wednesday/Thursday based on a leak of the mini-budget, and earning fortunes as a result. How does one ‘short’ a currency?
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the same way one shorts stocks or other investments.
you find someone willing to do the following deal with you:
at point X in the future I will pay amount Y EUR/USD for a specific amount pounds.
usually that “amount y” is the current exchange rate, so basically you bet that on that day you can buy that currency for less than you could do now while the other side hopes the value of the currency goes up.
You basically make any kind of deal which benefits you in case of the price of that currency falling in the (usually near) future. That usually involves derivatives.
‘Shorting’ some asset is to take a position that the value of that asset will fall, typically within a short period. For currencies, there are broadly (ELI5) two ways to do this.
1) Purchase a futures contract. Essentially that is a promise today that at some agreed upon time in the future, you will agree to exchange a certain currency for another currency at a certain exchange rate.
2) Borrow in the currency that you expect will fall in value, convert it to a foreign currency. For example, borrow 1 million pounds today, exchange it for 1.08 million USD. If the pound falls, then the value of that USD when converted back to GBP will net more than 1million pounds.
A ‘short sell’ works the same as with stocks.
With a normal investment, you buy the commodity for its current market price, then later on you sell it at market price. If the market price goes up, you make money on the deal. This is good because the most you can lose is whatever you invest- if the price goes down to $0 you’re left with nothing, but you’ve only lost whatever you pay for the commodity.
A short sale is a contract between you and your broker. Basically you make a deal that at some future date, you will sell the commodity to the broker at current market price.
So let’s say a stock currently trades at $100. I think it will go down. So I ‘short’ 1 share of the stock- my broker and I make a deal that at some future point I will sell them one share and they will pay $100 for it.
Let’s say the stock goes down and is now worth $50. I can close my short now- buy a share for $50 on the market and sell it to the broker for $100, resolving our contract and closing my short position. I’ve now made $50 on that deal.
Let’s say I’m wrong though, and the stock goes up to $150. If I want to close my position, I have to buy a share for $150 and sell it to my broker for $100, thus I lose $50.
For this reason, shorting opens me up to UNLIMITED losses- there’s no limit to how high the stock can go. Let’s say the company releases some Google-killer product and it goes up to $1000- to close my position will now lose me $900, because I will have to buy one share on the market for $1000 and sell it to my broker for $100. I’ve now lost $900 on a $100 investment.
For this reason, not all investing accounts support shorting. You generally need a ‘margin account’ which not all investors will qualify for (and many of those who do qualify shouldn’t do it anyway).
With currency it’s the same thing. If I expect GBP to go down, I might make a deal with my broker to short GBP for USD. So if 1 GBP currently = 1 USD, I make a deal with my broker that at a future date I’ll sell them 1 GBP for 1 USD.
If GBP goes down, and is now worth $0.5 USD, I can use my 50 American cents to buy 1 GBP and sell it back to my broker for 1 USD.
From a retail investor perspective, the best thing you can do is just avoid stocks/funds focused around that particular country.
Since 2016 (and then re-enforced in the 2019 election) I’ve not bought in to any UK focused funds or companies. It seemed obvious to me (especially after 2019) that the UK was going to flag relative to the global economy. And since I’m already heavily invested in the UK (house, job, etc) it seemed obvious to diversify into other economies.
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