One of the main differences between the stock and the currency markets is the ability to go short. More precisely, traders find it easier to short a currency pair than to short a stock.
The costs for doing so does differ. On the currency market, besides the commissions, spreads, and possible negative swaps, no other trading costs exist. But on the stock market, shorting a stock is much more expensive.
How to Go Short on the Stock Market
A recent statistic revealed that shorts are building positions in the Nasdaq index. The next shorts in the NASDAQ 100 index are the highest since 2008.
That is a way to short the stock market – by selling an index. Stock market indexes are offered by all brokers, in various forms. One form is a CFD – Contract for Difference. Shorting a stock market index in the form of a CFD is pretty much similar, like shorting a currency pair. The costs of doing it are also more or less the same.
Another way is to short the stock market index via an ETF (Exchange Trading Fund). ETFs are very popular nowadays because they represent a cheaper alternative for the retail traders to get exposure to markets that were otherwise expensive to trade. The trick on many ETFs is that they track a fund by moving faster or slower than the fund tracked. For instance, some ETFs may advance or decline twice as fast as the actual index. In this case, the reward, but also the risk, doubles.
To short an individual stock requires the existence of a margin account. Not all brokers offer such an account, and those that do typically have a minimum amount to invest. Also, regulations these days require a minimum level of financial knowledge on behalf of the trader.
Trading on margin means that the trader borrows the shares from the broker and sells them short. The problem with short selling an individual stock is that the upside risk is unbounded, but the downside potential is limited.
In fact, this is the main difference between currency and stock market trading. The price of a stock cannot drop below zero, limiting the potential profit. But the value of a currency pair may decline as much as it can rise, offering the trader possibilities to benefit both from the upside and the downside potential.