Lesson 12 – Forex Trades, What types are there?
When you start involving yourself in the forex market (or any market really), you’ll hear the phrases “going long” and “going short”. But often people don’t explain what they exactly mean.
Now we’ll explain what the two phrases mean
When “going long” is used in forex, it means to BUY a currency or commodity with the forecasted expectation that the price will INCREASE so that you can sell or close your position at that higher price for a profit. The idea is to buy low and sell high.
When “going short” is used in forex, it means to SELL a currency or commodity with the forecasted expectation that the price will DECREASE so that you can buy or close your position at a lower price for a profit. The idea is to sell high and buy low.
How does a trade take place?
When a trade is placed, it is also called entering ‘a position’. A ‘position’ is the amount of currency owned that is exposed to the market, with its value fluctuating against other currencies in the market.
Every currency trade that takes place happens as a pair. So when you go long on one currency, you automatically go short on the other.
The hopeful expectation is that when you enter that long position, you are hoping that the base currency rises in value versus the quote currency.
To use an example, let’s say we want to buy GBP/USD at 1.31. In this trade, we are going long on the British Pound, and short on the US dollar.
For this trade to be successful, we are expecting that one British Pound will be worth more than 1.31 US Dollars by the time we want to close the trade.
This is basically how forex trading works, and actually how all trading markets work in the world.
To show this, let’s take an example from the stock market.
If we bought some shares from Coca-Cola Co. (KO) at $30, this means we are going long on Coca-Cola Co. against the USD. This means we are going long on Coca-Cola shares whilst automatically shorting USD because we think that the price of Coca-Cola shares will grow faster than the value of the USD.
If we would re-write this as a forex currency pair, it would be written as KO/USD.
How does Shorting work?
While going long (buying) is easy to understand as a concept, a lot of people struggle with understanding shorting.
Put simply, shorting is the opposite of longing.
Put a bit more in-depth, when you short a currency, you SELL the base currency while you BUY the quote currency. This is how longing and shorting works simultaneously in every forex trade.
Using an example:
If we are shorting EUR/USD, we are selling the EUR and buying the USD.
To make it successful, we are hoping that the value of the EUR will decrease against the value of the USD.
This will mean we will be able to close our positions by buying back EUR at relatively a lower price and selling USD is at a relatively higher price. Thus making a profit.
When it comes to things like shorting stocks, while the idea behind it works similarly, but mechanically works differently.