Explanation of Forex Short & Long Positions
Trading currency in the foreign exchange, or forex, market is a hobby for some and a profession for others. Gaining an understanding of the methods and terminology used by traders forms the basis of learning to trade currencies. Becoming familiar with currency pairs, long positions and short positions lays the foundation for the novice trader.
Other People Are Reading
-
Currency Pairs
-
Currency prices are defined by their exchange rates. The exchange rate tells how much of one currency can be bought with another currency. When forex brokers display forex currency rates, they typically display the base currency first, then the quote currency. For example EUR/USD, the most common currency pair traded, is the euro and the U.S. dollar. The currency pair is always shown this way; never listed in the reverse.
When a trader buys EUR/USD, he buys euros and sells U.S. dollars at the same time. If he wants to buy U.S. dollars and sell euros, he would sell EUR/USD. The price shown with a currency pair tells the buyer how much the base currency, in this case the euro, will buy of the quoted currency, which in this scenario is the U.S. dollar. EUR/USD = 1.4760 shows that one euro buys 1.4760 U.S. dollars.
There are many currency pairs traded, however, most do not experience much volume, which makes profitable trading more difficult. Three major currency pairs with heavy trading volume are EUR/USD; USD/JPY -- U.S. dollar and Japanese yen; and GBP/USD -- Great Britain pound and U.S. dollar.
Long Position
-
When a trader buys a currency pair and holds it, expecting to sell it when the market price rises, he has a long position in that currency pair. For example, he buys EUR/USD at 1.4523 and holds a long position in it until the market price reaches 1.4623, then sells it and takes his profit. The trader aims to make a profit by selling the currency for a higher price than he bought it.
-
Short Position
-
A short position is the opposite side of a long position. A trader makes money in this trade by selling a currency pair and then buying it when the price drops. She wants to make a profit by buying the currency pair back at a less expensive price than she originally sold it. Forex and securities markets allow traders to sell assets they do not own, or in some cases, traders may borrow a security, sell it and then buy it back for profit and return the security. One way to think of short positions is that a trader holds a negative amount of the currency pair.
Closing Long or Short Positions
-
When a person initiates a trade, whether long or short, he has an open position. The position will be subject to ongoing movements in the currency exchange rates until the trade closes. To close out a long position, the trader needs to take the opposite position -- in other words, he will sell the same currency pair he previously bought in order to close the trade. While a trade is open, any profits are unrealized; the profits are taken once the trade closes out. To close a short position, the trader buys enough of the same currency to bring his position to zero, which closes the trade.
-
References
- Photo Credit Keith Brofsky/Photodisc/Getty Images
