On some days, currencies will go up in value. On other days, the currencies will go down in value. It is these fluctuations in currency prices that forex traders use to profit in Forex.
The objective of forex trading is to exchange one currency for another in the expectation that the price will change in your favour.
But before you start making money, you need to determine whether you want to buy or sell, or in forex terms take a long or short position.
If you want to buy (which means buy the base currency and sell the quote currency), you want the base currency to rise in value and then you would sell it back at a higher price.
In caveman talk, you’re buying British pounds to pay for all your wife’s favourite Harry Potter attractions, and selling U.S. Dollars. You’re hoping the value of Pound will rise by the time you’re back so you can make some extra dollah.
In trader talk, this is referred to as ‘going long’ or taking a ‘long position’.
Remember: long = buy.
If you want to sell (which means sell the base currency and buy the quote currency), you want the base currency to fall in value and then you would buy it back at a lower price.
To put it simply, you’re selling British pounds and buying U.S. dollars before catching a flight to California. You’re hoping the value of Pound will fall by the time you’re back so you can make some extra pennies.
This is referred to as ‘going short’ or taking a ‘short position’.
Remember: short = sell.
Joey has USD$12,700 to invest in the forex market. He decides to trade the currency pair GBP/USD which is currently trading at 1.2700. This means that one Pound buys 1.27 US Dollars. Joey does some research and believes the Pound will rise even more, relative to the US Dollar and so he exchanges his USD$12,700 and purchases £10,000.
Joey is correct in his assumption. The Pound strengthens against the US Dollar. It’s now trading at 1.3100. He now exchanges his £10,000 back into USD, except now it’s worth $13,100. As a result, Joey now has $13,100 in his trading account and made a profit of $400.
In the example above, Joey believed that the value of GBP would rise up against the USD, so he bought GBP/USD hoping to sell it later at a higher price.
Would you say that Joey took a long or short position?
Don’t worry if you get it wrong, after all you’ve only learnt the terms 2 minutes ago!
Joey made profit from taking a long position.
In another example, what should you do if you expect the GBP to go down against the USD? You should do the opposite – sell the GBP/USD with the hope to buy it cheaper later on. This is called going short and it is how you take advantage of exchange rates that are going down.
And that’s how money is made or lost in the Forex market in nutshell.