When you first start Forex trading, you will frequently hear the terms “long” and “short” relating to two different types of trades. It is often confusing to understand exactly what these terms mean, and no one ever seems to be able to explain it clearly. So, here is everything that you have ever wanted to know about this unfathomable subject. It can actually be summed up in fourteen words, but we thought you might want a little more detail!
Long Trade – Profiting from a rising market
Short Trade – Profiting from a falling market
Making Trading Easy
The easiest way to understand “long” and “short” trades is to think that your trade is doing one of two things. You are “long” if you will profit from a rise in relative value, and “short” if you will profit from a fall in relative value. Another way to clarify the difference is if you want to see the price rise in your chart, then you are “long”, and if you want to see the price fall, you are “short”. Simple right?
So, if you were dealing in stocks and you bought XYZ Inc. with Euro, you are “long” of XYZ Inc. and “short” of Euro. For you to benefit from any profit, either the value of XYZ Inc. stock has to rise against the Euro, or the value of the Euro must fall against the stock.
It’s important to understand this concept as every Forex trade with currency pairs requires that you go “long” in one position and “short” in the other.
What Exactly Are Long Trades?
These are the trader’s method of buying, with the intention of making a profit from a rising market, hoping that the price will go up. When you go “long”, you have unlimited potential for profit, as the asset can obviously rise in value limitlessly.
Although losses are always a risk, it is considered a lower risk than a “short” trade, as the price can only ever go down to “0”. That’s if your trade, unfortunately, moves in the wrong direction!
The Secret Of Short Trades
Here’s where it gets a little more complicated. Short trades, alternatively, are when traders have the intention of making a profit from a falling market. Traders actually borrow shares from a broker to sell “short”, when the price reaches a set target level. They subsequently buy back these shares, replace what was borrowed from the broker, and hope for a profit if they can buy for a lower price than they sold. It’s an unusual concept to grasp, as they are basically selling their assets before they even buy them!
Long and Short Forex Trades
When trading Forex, the principle is the same, but things are slightly different as you have a pair of currencies. As an example, when you open a “buy” trade, you have gone “long” on that currency pair. However, you are also always “long” and “short” in one currency each in that pair.
If your pair is GBP/USD, you are purchasing the GBP with USD, so you are also ”long” GBP and “short” USD. This is because if the price increases as you hope, it is the GBP that is appreciating against the value of USD. If you trade “short” in Forex, you are speculating that a currency will fall in value against its currency pair.
So, every Forex transaction always involves one currency with a “long” position and an expectation that its value will rise, and one currency with a “short” position and an expectation that its value will decrease.
Limiting Your Risk Exposure
Unlike any “long” trade where you can measure the risk involved when you are “shorting” any currency, you are speculating that it will fall. The reality is that the value could continue to rise, with theoretically no limit, so the risk is huge and immeasurable. The best way to control this is by placing a stop-loss order, which instructs the broker when to close the position if the currency keeps rising in value. In addition, you can place limit orders, which tells the broker to close your “short” when the currency falls to a certain value. This essentially locks in your profit and protects you from future risk on the trade.
Choosing Your Currency Pairs
In light of everything you have just read, the most important aspect of Forex trading is choosing the best currency pair. Along with your trading strategy, this is where the potential for profit lies. Get it wrong, and you have a high exposure to losing your money. It is not an easy decision, so the best way is to get some hands-on experience through a Demo account. You can then start trading on the Forex markets with a virtual balance to play with, and be well on your way to future success!