In order to make money in Forex, we will be Buying and Selling currencies. When you make a trade, you are simply converting one currency to another. Which currency you buy and which one you sell depends on the currency pair, as well as the position you take.
The first currency in a currency pair is known as the ”Base Currency”. In the GBPUSD currency pair, the Great British Pound is the base currency. The second currency you see is the “Team (Counter) Currency.” It’s the US Dollar in the GBPUSD pair.
You would buy the pair if you believe the base currency will appreciate (gain value) relative to the quote currency.
The object to Forex trading is to exchange one currency for another in the expectation that the price will change, so that the currency you bought will increase in value compare to the one you sold.
An exchange rate is simply the ratio of one currency value against another currency. For example, the USDCHF exchange rate, indicates how many US dollars can purchase one Swiss franc, or how many Swiss Francs you need to buy one US Dollar.
So, if the currency rate for the GBPUSD pair were 1.65, then you know that you can buy one unit of the base currency (the GBP) for $1.65 US Dollars. You also know that you can sell GBP and receive $1.65 Dollars for each Pound you own.
Buying vs Selling : Going long and short
Traders are said to be “going Long” when they buy a currency pair. When you “buy” a currency pair, you are buying the first currency (the Base currency) and Selling the second currency (the Counter currency).
Going “long” EURUSD means that you’re buying Euros with US Dollars. You’re long the EURUSD exchange rate because you traded Dollars for Euro.
Traders are “going Short” when they Sell a currency pair. When you Sell a currency pair, you’re selling the first currency (the Base currency) and Buying a second currency (the Counter currency).
Going “Short” EURUSD means that you’re buying US Dollars with Euros. You’re short the EURUSD exchange rate because you traded Euros for Dollars.
Let’s go through this again:
|Buy GBPUSD||Sell GBPUSD|
|Receive British Pounds,||Receive US Dollars,|
|Give US Dollars||Give British Pounds|
To put the trade into words:
- If you Buy the GBPUSD pair, then you’re Buying Great British Pound with Us Dollars.
- if you Sell the GBPUSD pair, then you’re Selling Great British Pounds to Buy US Dollars.
GBPUSD – This is the exchange rate for the British Pound and the US Dollar.
- If you think the Pound will gain value against the Dollar, then you would buy the GBPUSD pair. You would be ” going Long”
- If you think the Pound will lose value against the Dollar, then you would sell the GBPUSD pair. You would be ” going Short.”
USDJPY – This is the exchange rate for the US Dollar and the Japanese Yen.
- If you think the Dollar will gain value against the Yen, then you would buy the USDJPY pair. You would be ” going Long.”
- If you think that the Dollar will lose value against the Yen, then you would sell the USDJPY pair. You would be ” going Short.”
Here’s an example trad that will help you make sense of the matter. This example trade, is one in which the trader is buying the GBPUSD pair:
|Buy GBP at a price of 1.6 USD||+5,000 GBP||-8,000 USD|
|Sell 5,000 GBP at a price of 1.74 USD||-5,000 GBP||+8,700 USD|
|Total Profit||0 GBP||700 USD|
In this scenario, a trader purchases 5,000 Great British Pounds for $8,000 US Dollars at the exchange rate of 1.6000 Dollars per Pound. Later, after the exchange rate changes, the trader sells his or her 5,000 Pounds back for Dollars at a rate of 1.7400. The trader receives a total of $8,700 back for the 5,000 Pounds.
After subtracting the original investment of $8,000 US dollars, the trader earns a profit of $700 US Dollars.
Trader’s Action EUR USD
You purchase 10,000 euros at the EURUSD
exchange rate of 1.1800. +10,000 -11,800*
Two weeks later, you exchange your 10,000
euros back into U.S. dollars at the exchange rate
of 1.2500. -10,000 +12,500**
You earn a profit of $700 0 +700
* EUR 10,000 x 1.18 = US $ 11,800
** EUR 10,000 x 1.25 = US. $ 12,500
Now, let’s see how you can make a trade base on what you think about a currency. You have these two thoughts about the Dollar and the Euro:
- You think that the US economy is going to get weaker in the coming weeks or months because people are losing their jobs. The US dollars should fall in value.
- Meanwhile, you think that the European economy is going to get stronger, since the European economy is adding jobs. The Euro should rise in value.
So how would you make this trade with the EURUSD pair?
Well, you want to make money if the Euro goes up in value against the Dollar. So, you would buy (go Long) the EURUSD pair, since buying the EURUSD pair will give you a profit when the Euro strengthens. In effect, you’re swapping soon-to-be more valuable Euros.
After the Dollar gets weaker, you would trade back your more valuable Euros for less valuable Dollars and have more dollars than you had when you made the prediction.
When to buy or sell?
If you want to buy (which actually 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 trader’s talk, this is called “going Long”. Just remember: long = buy.
If you want to sell ( when actually means sell the base currency and buy quote currency), you want the base currency to fall in value and then you would buy it back at a lower price. This is called ” going short” or taking a ” short position”. Just remember: short = sell.