Hello. Few years ago I used a Marketmaker on leverage (Trade.com) to trade currencies, commodities, etc. For each security I had the option of buying and selling it (whether it was a currency, a commodity, etc).
I understand the mechanism of buying a security, and selling it when it’s price is higher: the difference is my profit. Good.
But how does it work when I SELL the security without owning it in the first place? What am I actually ‘buying’ when I press the SELL button amid not owning that security in the first place? What’s the math behind this and where does the profit come from when security’s price goes down?
In private retail forex trading you are not buying or selling anything. You are speculating (betting some would say) on the movement of the exchange rate between two currencies.
You are not buying or selling either currency. Nevertheless, if you open a long position on the EUR/USD exchange rate, and the value of the EUR rises, you will accrue financial rewards in the same way as someone who had bought bundles and bundles of EUR, using USD to pay for them. So because your benefits as a forex trader are parallel to the benefits of a currency owner we talk about “buying” EUR/USD as a kind of short-hand.
As Tommor pointed out, you’re not really buying or selling anything when you trade the retail forex market.
I think what you’re asking about is “shorting” the market. Let’s take the stock market as an example. If you buy a stock you’ve taken a long position in the market. You can request the physical delivery of stock certificates that you purchased or, as a typical trader you will “sell” the shares that you purchased, hopefully for a profit.
But, let’s say that you believe that a particular company, say Acme Inc (don’t know if that is a real company), will see a decline in their stock price. You don’t own any stocks of Acme Inc., however. In that case, if you want to profit from the decline in Acme’s stock prices, you can “borrow” the number of shares of Acme that you would like to sell, from your broker. The broker lends you the shares that you wish to sell when you place a sell order for Acme. Such a transaction is termed as a “short sell”. At some point in the future you will need to return those shares to your broker. When the price of Acme’s stock falls and you decide to exit the market for profit, you close the trade. In effect, you are “covering” your short. By closing the trade you have bought back the shares of Acme at the lower price and returned those to the broker. All of this recorded in the brokers blotter, which is entirely digital nowadays.
We do use the terms “long” when buying and “short” when selling but really the term “short” for retail forex is misused and perhaps it has been carried over from other markets in which one may participate in a short sell.
Its different for currencies vs stocks or even commodities.
For currencies, you are either buying the base currency and selling the quote currency or you are buying the quote currency and selling the base currency. which one depends on whether you think the exchange rate for the pair is going to go up or down. As long as you have currency, you can buy any other currency and sell it to purchase another.
For stocks and commodities, you are borrowing the asset, selling it, then buying it back at a lower price. Then giving the asset back to the person that lent it to you. The difference is a profit and this is how you make money shorting (selling assets you do not have).
But, as the others have said, you are just speculating on the price movement. The actual mechanics of what goes on behind the scenes doesn’t really matter that much and this is not what really happens on retail Forex trading platforms.
More often than not, you are trading CFD’s, Contracts For Difference (in price).
