Long and Short in Forex - How Does It Work?
By Stjepan Kalinic, Updated on: Jan 11 2024.
Going long means opening a trading position where you expect the price of an asset to increase in order to profit. Going short means opening a trading position where you expect the price of an asset to decrease in order to profit.
The forex market is a specific phenomenon. Although one could argue that owning currency is like being a shareholder in a certain nation, currencies don't trade like shares. They are always compared to other currencies, trading in ratios that fluctuate according to the macroeconomic changes.
Read on to learn more about forex and how it differs from other markets.
What is Forex?
The foreign exchange (forex) market is a global market for currency trading. It operates as a decentralized network of financial institutions around the globe, on a 24-hour basis opening with the Australian market on Monday and closing with the U.S. session on Friday.
Since currencies do not trade in absolute value, they are listed as ratios. For example, the most liquid currency pair, Euro vs. U.S dollar, is abbreviated as EUR/USD, with International Organization for Standardization (ISO) codes associated with the national currency.
The forex market rose to prominence in the 1970s, after the breakdown of the Bretton Woods fixed exchange system (gold standard). As currencies started floating, optimizing the currency exposure to facilitate foreign trade made the foreign exchange a necessity. Eventually, forex became the most significant financial market with daily volumes exceeding $7 trillion.
Retail forex trading became popular in the late 1990s, as the online forex brokers popularized high leverage, low-latency trading with a competitive cost structure due to high liquidity. Nowadays, some estimates show that retail traders account for over 5% of the daily forex market trading volume.
What is a long forex position?
Going long or buying is taking a stance that something will rise over a period of time. Since currencies trade as a ratio, buying means that you are betting that one currency will get stronger against another. In the short term, this can be just due to intraday fluctuations, but this will always be driven by macroeconomic factors like interest rates or GDP projections in the long term.
Example of a long forex position
Let’s say that you are expecting the U.S. dollar (USD) to appreciate against the Swiss franc (CHF). The pair currently trades at 0.92. You go long USD/CHF, buying 1 lot, or 100,000 units. Now you have bought USD with CHF, expecting the value of CHF to go down so that the value of your position goes up.
In the next hour, USD/CHF appreciates to 0.92250 or 25 pips. Your profit ends up being 25 x 10.86 (USD/CHF value per pip) = $271.44
What is a short forex position?
Going short or selling is expecting that the value of something will decline over time. However, selling a currency means betting that another currency will rise against it.
If you are selling Euro (EUR) against the U.S dollar, you’re expecting the U.S. dollar to gain in value against it.
Example of a short forex position
Consider the following example — EUR/USD is trading at 1.13, and you decide to go short and sell 1 lot (100,000 units). You're selling the euro and buying the US dollar, expecting its value to appreciate.
Eventually, the price drops to 1.12750, and you decide to close your position, buying back the euro that you sold at a lower price. Your profit would be 25 x 10 (EUR/USD value per pip) = $250.
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How to make money in Forex?
Forex might be simple to learn, but it is hard to master. If you want to make money consistently, you will need to be patient and disciplined.
Here is the list of things to consider when pursuing forex trading
- Set realistic expectations: Trading, in general, is not easy. It is a constant battle between fear and greed, and the rollercoaster of emotions can ruin many talented traders. In trading, it all starts with a plan – knowing when and why you'd get in and get out even before you do anything. This plan has to be realistic. Capturing a large move will happen from time to time, but not every day. For example, a good target for intraday traders is to look for 20-25% of the average range for a particular currency pair.
- Find a style that suits you: It is much easier to discover what suits you than forcing you to fit your personality to a certain trading style. Whether it is short term or long-term, scalping or swing trading, you need to figure out which approach is the most optimal for your skillset.
- Use a protective stop-loss: Trading without a stop-loss is an accident waiting to happen. In the financial markets, anything can happen at any time. Unannounced central bank decisions, terrorist attacks, presidents getting on Twitter – there are many reasons why you should limit the potential losses. This might depend on your strategy, and market structure, but a good rule of thumb is to use at least 10% of the daily range for the stop loss level.
- Develop your own ideas: At times you will find someone's research online and decide to act upon that idea. While it might turn out fine, you have to understand that losses are an inevitable part of trading. Losing money on an idea that isn't yours might lead to losing the sense of responsibility since you will rarely have the full rationale behind it. Developing and journaling your own ideas might be taxing in the short term but pays off down the road.
- Trade volatile but liquid currency pairs: It is hard to catch a decent move if the currency pair you want to trade doesn't move a lot. Optimally, you're looking to trade a pair that has a relatively large daily range but it is popular enough to be liquid. This will ensure 2 things. First, you will on average catch bigger moves. Second, your trading will be cheaper, because spreads will be tighter.
- Avoid using too much leverage: Leverage is a tricky concept. It can be the medicine or the poison – depending on the dosage. In recent times some regulatory agencies have restricted maximum leverage for retail clients. For example, in the U.S, it is 1:50, while in the EU, it is 1:30. However, some offshore brokers will offer leverage as high as 1:500, or more. Avoid the temptation to over-leverage your account.
- Keep track of news: High-impact news can make or break the trade. Often the market overreacts and shakes out the weaker positions before finding the direction. Arguably, the worst thing is to be right but too early. Thus, keep track of the news and preferably avoid taking any fresh positions around them unless you have a really good reason. Naturally, every intraday trader should keep track of the news calendar for the day, while swing traders should track the news days in advance.
It is All About the Ratios
Although it might seem complex initially, going long or short on currencies is similar to any other market. You are speculating that the price will rise or fall in the future. Yet, currencies trade in ratios, so in this case, you are buying or selling the money itself.
Forex might be simple to understand, but it takes a long time to master. However, if you take the time to discover what suits you and implement the tips from this article, you will find yourself on the path to profitability.
Frequently Asked Questions
How do you trade in a short time?
Short-timeframe trading involves following the price movement on a timeframe that is lower than 1 hour. Usually, it is on 5 or 15 -minutes charts. Some traders might even use 1-minute trades, despite the unavoidable market noise on those timeframes.
Short-term trading can be either with the long-term trend or against it, catching the counter-trend moves as price withdraws to the mean. There are numerous short-term trading strategies, but some of the most popular include Fibonacci retracement, moving averages, and Elliot Wave analysis.
How long is short-term in forex?
Although there is no consensus, the short-term generally covers a period from a few minutes to as long as a few days. However, it is less than one week.
One advantage that forex has over stocks is that it has no pattern day trade rule that prevents traders with a capital lower than $25,000 to make 4 or more day trades over 5 business days using a margin account in the U.S.