Playing against the Yen: the best options

What is a short position?

Dozens of thousands of successful traders use short positions on Forex. However, it is easier to explain how the shorts work using the example of securities or stocks. Let’s assume that a trader performed market analysis and is convinced that IBM stock will crash by the evening. He can profit from this by taking the following steps. A trader borrows 100 IBM shares from his broker and sells them immediately at their stated price, let’s say USD 150 per share. In the evening, the stock price drops to USD 120, the trader buys 100 shares and returns the debt to the broker.

How much will he earn by opening a short position at the exchange? 100х150= USD 15,000 – this is the amount he sold the shares for. 100х120= USD 12,000 – and this is the amount he later bought the shares for in order to return them. USD 15,000-USD 12,000=USD 3,000 – that’s how much he earned (minus the trading fee). It is a very simple mechanism. You use the same principle to open short positions on US dollar or other currency in order to first sell the borrowed funds and then buy them, when the price drops, and return to the broker.

How does a short position work on Forex?

In Forex, short refers to selling a currency to profit if it loses value. Opening a position entails the move made by a trader to "sell" a currency pair. A trader may open a position to "sell" a currency if they anticipate a decline in its value.

Most often, during short selling, you will be borrowing an asset you do not own from a broker to sell against another currency. Typically, the broker is in charge of borrowing and selling the asset.

For example:

In the currency pair USD/JPY = 136.19, the Forex quote indicates that $1 can be bought for 136.19 Yen.. Trader A assumes that, in the future, USD will rise in value relative to the Yen, i.e., the rate of USD/JPY will decline.

Let’s say Mr. A borrowed 1500 dollars and sold it against the yen (1500 x 136.19) in the market, and after some days, USD/JPY = 130.05. According to the current situation, Mr. A's prediction of a price decline was correct. So Mr. A hurriedly purchased back the 1500 dollars to refund the broker using the new rate.

The profit Mr. A made from shorting the Yen in this transaction can be calculated by comparing the price difference.

What you should know before you short the Yen

Stockbrokers’ trading conditions may include fees on using borrowed funds for short positions. CFD brokers don’t charge such fees, but do charge swaps, i.e., fees on keeping positions open overnight that depend on official discount rates. If a short position is closed by the end of the trading day, the fee is not charged.

This introduces margin lending, which is borrowing to invest in Forex using existing investments as security. This kind of security is used as collateral for Forex short positions. Until the position is closed, a certain amount on your account will be blocked to act as collateral. It is necessary to have this "initial margin" to open a position. The formula for calculating it is the price of the asset multiplied by the risk ratio.

The amount needed in the account to support opening the position is known as the minimum margin, which equates to 0.5 of the initial margin.

Note that the collateral is what the broker protects itself with until the time when you return the loan. Consider the cost of the liquid portfolio, which is determined by applying the formula: the value of the assets on the client's account minus the broker debt, before opening a short position at the exchange.

The broker will decline the trade if the portfolio's liquidity is low. Additionally, consider the leverage and risk-to-reward ratio of the exchange. The risk ratio shows an asset price change, while the leverage determines the loan potential.

The above example of margin trading is relevant for stockbrokers. CFD brokers also have the notions of used margin, free margin, and margin level:

If the margin level drops lower than the value set by the broker, trades are automatically closed at the expense of the trader’s collateral.

Risks and opportunities of a short position on Forex

Everything is rather clear with the opportunities short selling on Forex offers – a trader can profit from a decline of an asset price (currency, stock, commodity – short positions can be open on anything) in a short time. In fact, it is possible to earn rather a lot, if your prediction of a strong collapse of the price turns out to be right and if you smartly diversify the risks. Experienced traders make USD 2,000-4,000 a week on shorts and that’s not the limit.

There is a nuance: as was already mentioned, trading conditions may include payment for the so-called margin trading, i.e., payment for borrowed funds. For example, CFD brokers don’t charge such fees, but they do charge daily swaps (fees on keeping positions open overnight) that also apply to short positions. Stockbrokers can charge APRs on loans granted for short positions. For example, for every $1,000 borrowed at an APR of 13 %, you will pay $130 per year or $0.36 per day. If a short position is opened and closed on the same trading day, charges don’t apply.

The other important nuance of a short position at the exchange and on Forex is the increased risk due to the mathematical expectation. To put it simply, when you buy an asset, its price can grow indefinitely, so your profit has no limit in the future. Meanwhile, the price of an asset can only drop to zero, which means your loss is limited to a strictly invested amount. That is, by buying securities or another asset for USD 1,000, you have the opportunity to earn $5,000 or more, but you can lose only USD 1,000.

In the case of a short, everything is the other way around – your profit is always strictly limited, but your loss isn’t. Taking into account that you are trading borrowed funds, the broker will not let you lose too much (that’s what the margin with the risk ratio is for); in case of a bad trend, he will take part of even all funds that were locked on your account as the loan collateral.

Squeeze is the biggest risk of a short position. It is a situation, when a trader becomes a hostage of his own actions. For example, he actively buys currency futures, thus creating the demand and causing the asset price to grow. Bears, who bet on the price to fall, are not happy about it. So they open short positions selling the asset with the intention to buy it later, when the price drops. If the effort of the bears is not enough and the trend does not change, they are forced to close the positions at the market price to avoid losing more money. This however only makes the trend stronger.

A short squeeze is a situation where the asset price rises rapidly due to forced closure of short positions. The price goes up under the pressure from buyers, and sellers have to close short positions manually or through stop-loss orders. Short positions are closed as the asset is bought, and the additional demand pushes the price up even faster. The short squeeze is a problem for sellers because it happens suddenly, quickly, and with slippage. This risk should be taken into account in trading strategies.

Account types for shorting currencies

Currency trading options

There are two ways to trade currency and currency instruments: trading with a stockbroker or a CFD broker.

Futures are also a contract. Under this contract, the seller undertakes to supply the asset to the buyer at a state price after a stated period, and the buyer undertakes to buy this asset. The key benefits include a “built-in” leverage (because it is not necessary to pay for the contract in full), low fees and it is possible to hedge positions.

The cons are predictable. First of all, it is impossible to “wait out” the bad trend. For example, if the price of an asset suddenly started to climb, it is not beneficial for the trader to wait until it starts decreasing. First, he pays a fee for each day of waiting. Second, there is a variation margin, because of which he will either have to replenish the account or close the position.

CFDs (contracts for difference) are concluded for a certain period, and the trader gets the difference of the asset price at the time of opening and closing of the trade. CFDs have a rather low collateral, there is no need to wait for the validation of the opened orders and stop orders are closed under any conditions. Other advantages include high leverage and low deposit requirements.

However, a short on Forex using CFDs has a number of drawbacks. For example, it is not an investment instrument. A trader does not own the asset, and all transactions are strictly speculative. Furthermore, CFDs carry a high level of risk that is difficult to diversify, especially when trading with high leverage.

Account types for shorting currencies in CFD trading

CFD brokers offer two primary account types:

How to short Yen – a step-by-step guide

Before you start learning how to short the Yen, ensure you understand currency pairs. First, each currency quote is presented as a "two-sided transaction." It means that if you are selling the USD/JPY pair, you are selling U.S. dollars to buy them later at a lower price when the exchange rate drops.

But you can borrow from the broker to sell against other currencies (open a position), then buy when the price declines to refund the broker (close a position). The steps below explain how you can short the Yen:

How to manage risk when shorting the Yen

If a trader thought a currency's value would decline, which could happen due to some factors, they would short the currency. You might never recover your losses if you bet against the market and the asset's price continues to rise. So you should learn to implement some risk management strategies. Below are ways to manage risk on your accounts when you want to short the Yen.

How to short Yen with ETFs - 4 Best options

In general, currency ETFs give investors quick and inexpensive access to foreign exchange markets during trading hours. It ensures international investors gain exposure to the Japanese yen. A Yen exchange-traded fund (ETF) monitors the performance and relative value of the yen against a basket of other currencies or a single currency.

Additionally, they enable investors to diversify their holdings, and they can be used to profit from arbitrage opportunities or protect against significant economic events. Here are the 4 best ETF options for traders looking to short Yen with ETFs.

1. The Invesco currency shares the Japanese Yen Trust (FXY)

Among the best ETFs to short the Yen with, the Invesco CurrencyShares Japanese Yen Trust (FXY) is the most common. This ETF trades under the ticker symbol FXY and holds physical Japanese yen in its account while tracking the price of the yen.

With over $144.6 million in assets under management (AUM), FXY seeks to mirror the price of the yen relative to the USD. And that's with a 0,4% expense ratio. Compared to other ways of investing in the foreign exchange market, FXY fund shares are a more affordable option.

The price of the ETF’s shares rises as the USD/JPY rate drops, i.e., as the Yen gets stronger.

2. ProShares UltraShort Yen ETF (YCS)

ProShares UltraShort Yen ETF (YCS) is a leveraged inverse fund, a trading vehicle rather than a long-term investment known to be extremely volatile. YCS offers inverse currency opportunities for euros and the Yen. Additionally, it seeks daily investment returns that are twice (-2x) as successful as the yen's daily performance against the U.S. dollar.

The fund is inverse. As the USD/JPY rate drops, i.e., as the Yen gets stronger and the U.S. dollar gets weaker, the price of the ETF’s shares will decline.

This ETF is for investors who want to hedge against the current yen or bet on the Japanese yen performing poorly against the U.S. dollar. YCS invests in the foreign exchange markets with a 0.95% expense ratio and a total asset base of about $24.45 million. YCL provides a way to make a leveraged bet on the yen, wagering that the Japanese yen will rise in value soon relative to the US dollar.

Due to its daily leverage, YCS is only suitable for investors who have the time and resources to monitor and rebalance their holdings. As such, it should never be part of a long-term portfolio. Its goal is to make investments in any financial instrument—or combinations of financial instruments—that, in a typical market, correspond to the benchmark of the fund.

3. ProShares Ultra Yen ETF (YCL)

Another ETF you should consider is the ProShares Ultra Yen ETF, a direct fund, which invests in the currency markets. This is a rare leveraged ETF, and the fund makes investments in line with normal market conditions to meet its investment objective. As collateral for financial instruments and pending investments in financial instruments, it will also hold cash or cash equivalents like U.S. Treasury securities. Including other high credit quality short-term fixed-income securities or comparable securities.

YCL provides 2x long exposure and invests in Yen trading against the U.S Dollar using derivatives like forward contracts. The fund aims to follow daily changes in the spot price of the Japanese yen relative to the U.S dollar by a factor of two. And this is with an expense ratio of 0.99%.

4. WisdomTree Japan Hedged Equity Fund (NYSEArca: DXJ)

Another excellent ETF choice is the WisdomTree Japan Hedged Equity Fund (NYSEArca: DXJ), which invests in Japanese stocks. This ETF limits or guards against fluctuations in the value of the US dollar and Japanese yen. Additionally, the fund is expensive compared to Japanese ETF products.

It keeps track of price and yield changes in addition to safeguarding against the negative effects of a falling yen. And that's before considering the WisdomTree Japan Hedged Equity Index's fees and costs. DXJ, which has an expense ratio of 0.48%, is the best option for investors who anticipate a decline in the value of the yen relative to the dollar but are still looking to buy Japanese stocks.

When should I short Yen

The Japanese Yen is vulnerable to several significant factors. These elements could cause the Yen to decline, which is good news for short-term traders. Let's see some of the main drivers that can weaken the JPY price:

The question now is when is the best time to short the Yen? The answer to this is that you can short the Yen whenever any of the above factors are present. Therefore, anticipate significant changes in the price of the JPY whenever you hear about periods of uncertainty that results to:

Macroeconomic trends that affect JPY currency valuations include growing trade deficits, slower economic growth, and rising public debt levels. To put it another way, shorting Yen can be a smart way to profit from price shifts before they happen if you notice specific price signals that indicate Yen is about to go down.

JPY/USD price prediction

The US Dollar/Japanese yen (USD/JPY) currency pair belongs to the group of the best currency pairs for trading, as it is highly liquid. This pair is particularly interesting for scalping and day trading.

The popularity and high liquidity of USD/JPY can be explained by economic factors, as the U.S. and Japan hold key positions in the global economy. Forex market is used to ensure foreign trade transactions. Forex traders can earn their profit on currency price fluctuations.

Best Forex brokers for short selling

Experienced traders recommend shorting with CFDs and on ECN accounts, but not all brokers offer good conditions for these instruments. Below, we will briefly describe the platforms that have been recognized as leaders in their segments.

RoboForex – Best ECN Broker

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The broker offers ECN accounts on exclusive conditions – 10$ minimum deposit, spread from 0 pips, leverage up to 1:500/1:2000. Thanks to high liquidity and lightning-fast order execution, you can implement any short-term strategy. ECN accounts are available for currencies (36 pairs), precious metals, and cryptocurrencies. Trading is available on MT4, MT5 and cTrader platforms. The fixed fee on 1 full standard EUR/USD lot on an ECN account is $2.

IC Markets – Best CFD Broker

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Up to 75.93% of the broker’s non-professional clients incur losses when trading CFDs.

The broker offers CFDs on all types of assets; there is also a demo account for testing strategies. The spread from 0 pips, trading is available 5 days a week on MT4, MT5 and cTrader platforms. The leverage is up to 1:500 on MT platforms, up to 1:30 on cTrader. IC Markets is one of few brokers offering CFDs on Bitcoin and dozens of popular altcoins. Thanks to spread from zero, it is more beneficial to trade CFDs rather than currency directly. The broker’s pool features over 2,000 and it is licensed by ASIC and CySEC.