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How an FX trade Works

The objective of currency trading is to exchange one currency for another in the expectation that the market rate or price will change so that the currency you bought increases in value relative to the one you sold.

Any foreign exchange transaction ultimately begins with two events:

One currency has been purchased

The other currency (of that pair) has been sold.

The currency that has been sold will needed to be funded on a day to day basis, and the currency purchased will earn interest.

After gaining an intuitive understanding of how exchange rates move, one can begin FX trading, thereby speculating on the exchange rate so as to potentially reap profits from the fluctuating value of currencies.

Going Long or Short 

A long position is when a trader buys a currency at one price with an aim to sell it later at a higher price. In this scenario the trader will benefit from a rising market (price goes up) and must sell the currency back in order to lock in the profit. This is also referred to as the notion of "buy low, sell high" in other trading markets.

For example:

A trader believes that EUR/USD is moving higher and buys 10,000 EUR at 1.4200 (sells 14.200 USD). Assuming they are right and EUR/USD goes up to 1.4250/1.4253 they then decide to close the position: when you close a long position you sell the base currency (10,000 EUR in our example) and buy the quote currency (10,000*1.4250 = 14250 USD):

Transaction

EUR

 USD

Open a position:
buy EUR and sell USD 

 + 10,000

 - 14.200

Close a position:
sell EUR and buy USD 

 - 10,000

 + 14.250

 
Total:

 
0

 
+ 50

 

A short position is one in which the trader sells a currency in anticipation that it will depreciate, and they can buy it back later at a lower price. Under this scenario the trader is looking for a ‘falling market' and must buy the currency back in order to lock in the profit.  This is the opposite of a long position.

For example:

A trader believes that GBP/USD is moving down and sells 10,000 GBP at 2.0400 (buys 20,400 USD). Assuming they are right and GBP/USD goes down to 2.0300/2.0305 and you decide to close the position: when you close a long position you buy the base currency (10,000 GBP in our example) and sell the quote currency (10,000*2.0305 = 20305 USD):

Transaction

EUR
 

 USD

Open a position:
sell GBP and buy USD  

 - 10,000

 + 20,400

Close a position:
buy GBP and sell USD 

 + 10,000

 - 2.0305


Total:

 
0

 
+ 95

 

More trading technology 

On trading platforms, you will notice that there are two prices for each currency pair. Similar to all financial products, FX quotes include a "bid' and "offer" (also known as ‘ask'). 

A bid price is the price that a buyer (fx provider) is willing to pay to purchase a particular currency pair and where the counterparty (clients) can sell that currency pair at a particular time. 

An offer or ask price is the rate at which the seller (fx provider) is willing to sell a particular currency pair and where the counterparty (clients) can buy that currency pair at a particular time. 

The bid/ask combination makes up a quotation, which is based on a floating exchange rate. For example, in the EUR/USD pair, the quote might be 1.4150/55. 

 

Follow these links to learn more about FX Trading.

FOREX BASICS

 

TRADING STRATEGIES

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Source: LatitudeFX Limited

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