Long or Short Forex Positions
Learn what factors are important when trading Forex, when to go long or short on currency pairs, and how to use various trading orders.
Alvexo has designed this Forex trading article with one goal in mind: to make you a better Forex trader. The Forex market is the world’s most heavily traded market, with estimated daily turnover of $4 trillion. Institutional investors and retail investors engage in currency trading 24-hours a day, 5-days a week.
It is especially important to understand the basics of the currency trading arena before you begin investing in it. Once you have completed the Alvexo series of Forex training courses, you will be better poised to make smarter trading decisions with higher success rates in your trades.
Understanding Currency Pairs
You can trade most every currency in the world, including major currency pairs, minor currency pairs, and exotic currency pairs. Major currency pairs include AUD/USD, USD/CAD, GBP/USD, EUR/USD, USD/JPY and USD/CHF.
The US dollar makes up over 95% of all global Forex trading activity. Minor currency pairs include less frequently traded currency pairs, and even the EUR/GBP currency pair straddles the line between major and minor.
Exotic currencies include the Singapore dollar, the Mexican peso, the Indian rupee, the Hong Kong dollar, the South African rand and the South Korean won among others. These currencies typically include the USD as the base currency, and the name is derived not from the country of origin, but rather differing liquidity conditions.
What is a Base Currency and What is a Quote Currency?
Let us take a look at the EUR/USD currency pair. If the exchange rate is 1.2142 dollars for every euro, the EUR/USD price would be written as follows EUR/USD = 1.2142. The base currency is the euro and the quote currency is the US dollar.
This Forex pair indicates that €1 can buy $1.2142. Investors can generate returns buying currency pairs through an appreciation of the quote currency, or a depreciation of the base currency. Consider that instead of €1 = US$1.2142, there has been a depreciation in the base currency such that €1 = US$1.2242.
In this case, the appreciation in the Euro makes it clear that fewer euros will get you $1.2142. Therefore you have made a profit trading this currency pair. This begs the question: how do you know which way the base currency or the quote currency is going to move?
If you refer to our section on market indicators, you will know which types of indicators can assist you in spotting trends, reading market movements and understanding peaks and troughs and their associated turning points for currency pairs. Forex trading tools like MACD, Bollinger Bands, RSI and stochastic indicators are a good place to start.
Going Long or Going Short Currencies
For the purposes of illustration, let us assume that US Gross Domestic Product (GDP) has exceeded forecasts and traders are now feeling bullish about the US economy. This will invariably lead to positive sentiment vis-a-vis the US dollar which will likely lead to immediate gains in the dollar.
The converse also holds true. If we expect the US to raise interest rates at the end of the quarter, we can posit that this will bode well for the strength of the USD. This will make the US dollar more valuable in international markets since high interest rates are associated with a lower money supply.
Foreign investors will be exchanging their currencies for US dollars to invest in the US market. This has the effect of weakening foreign currencies and strengthening the US dollar. Fortunately, with forex trading you don’t need to take physical possession of the currencies in order to trade them. You are taking a position – speculating on what the base currency and the quote currency are likely to do in the future.
We have already introduced you to the concepts of going ‘long’ and going ‘short’ currencies in the above paragraph. Going long means that you have a positive expectation on the future value of a currency and going short means that you have a negative outlook on a currency.
In the following currency pair AUD/USD you could make a profit by going long the Australian dollar, if the Australian dollar is expected to strengthen against the US dollar. By the same token you can trade the same currency pair and go short the Australian dollar and make a profit if the Australian dollar weakens against the US dollar.
As we have indicated with the discussion of interest rates, your outlook for a particular currency is either bullish or bearish. If you have a bullish approach, you tend to go long a currency and if you have a bearish approach, you tend to go short that currency.
Forex Trading Orders
There are several different types of orders offered by brokers in the Forex world. These include Stop-Loss Orders, Trailing Stop Orders, Take-Profit Orders, Limit Orders and Market Orders. Depending on your particular trading style, you will choose in order type that best suits your trading needs.
Stop-Loss Orders are geared towards stopping you from incurring further loss on your open Forex trades. It also helps you to avoid margin closeouts. This type of Forex trading order is especially useful since it works to protect you from further loss when the exchange rate goes against you.
Stop-Loss orders do not completely eliminate risk, they only restrict your losses. Forex experts encourage all traders to take out Stop-Loss orders for all open positions.
Trailing Stop Orders
Trailing Stop Orders are similar to stop loss orders since they close out positions if the market moves against you. What separates a Trailing Stop-Loss from a Stop-Loss order is that the former feature ‘trails’ alongside the market price (when it is positive) until such time as it takes a downturn.
Once that happens the trailing stop order kicks into effect. The beauty of the Trailing Stop Order is that you can continue to generate positive returns without following your Forex trades, knowing that when the market moves in the opposite direction the stop order will kick in.
Take-Profit Orders close open orders when a specified threshold has been reached. This is a solid way to lock in your profits when you are not around to monitor your trading activity.
You can automatically set take profit orders for any currency pair that you are trading. Once that exchange rate has been reached and the bid price touches your threshold, the open position will be closed.
It does not always work the way you expect, since the rapidly changing marketplace can cause some degree of variation between the rate that you set and the closing rate.
Limit Orders only go into effect when specific conditions are met. When you are buying or selling a currency pair, your limit order must meet the trade stipulations to be fulfilled.
Certain types of limit orders can automatically be executed when the exchange rate hits a specific level. If you wish to go long the AUD/USD currency pair, you could initiate a limit order at an exchange rate below the prevailing market rate.
Once that lower rate is hit, the limit order will kick in. Opposite to long positions, limit orders to open short positions are placed above prevailing market prices.
Market Orders are executed the moment they have been placed. They are priced according to the market price. Once the market order is active, it is an open position. If the rate moves against you, your position will deteriorate.