How Does a Trade Work in Forex Trading?

Every trader who enters the forex markets wants to know one thing – how to make consistent profits in the forex markets? Well, there’s no one answer here. You might be a talented successful trader that can make money from day one. Or, it might take some time for you to become a successful forex day trader.

Nonetheless, there are some basic things you need to know when you start trading currency pairs. Firstly, you need to know how a forex trade works, what is long and short positions, and how you can make high profits from your winning trades.

Let’s start then.

First, How Does a Trade Work in the Forex Market?

Much like any other market, foreign currency prices fluctuate all the time. So,  on some days, currencies will go up in value, and on other days, the currencies will go down in value. It is these fluctuations in currency prices that a Forex trader uses to start making profits in the Forex market.

For many traders, the investment objective of Forex trading is to exchange one currency for another with the expectation that the price will change in your favor. For that matter, a trader opens a forex account and learns how to use Forex trading platforms. Then, the trader develops a forex trading strategy by using technical analysis tools, and general market commentary.

But pay attention – before you start making money, you need to determine whether you want to buy or sell when you make a trade, or in Forex terms take a long or short position.

Long vs Short Positions in Forex Trading

Foreign Exchange trading involves the buying and selling of one currency versus the other. As such, if you want to buy a currency (which means buy the base currency and sell the quoted currency), you want the base currency to rise in value and then you would sell it back at a higher price. In other words, you want the exchange rate of the currency pair to rise.

In caveman talk, you’re buying British pounds to pay for all your wife’s favorite Harry Potter attractions, and selling U.S. Dollars. You’re hoping the value of the Pound will rise by the time you’re back so you can make some extra dollars.

In trader talk, this is referred to as ‘going long’ or taking a ‘long position’.

Remember: long = buy.

On the other hand, if you want to sell (which means sell the base currency and buy the quote currency), you want the base currency to fall in value and then you would buy it back at a lower price.

To put it simply, you’re selling British pounds and buying U.S. dollars before catching a flight to California. You’re hoping the value of the Pound will fall by the time you’re back so you can make some extra pennies. 

This is referred to as ‘going short’ or taking a ‘short position’.

Remember: short = sell.

Unlike most financial markets like the stock market, this is the beauty of the Foreign exchange market. You can easily trade foreign exchange currency pairs in both directions, meaning taking long and short positions. There are no strict margin requirements from your forex broker and there are more trading opportunities than other markets. Furthermore, most forex brokers allow you to start buying and selling currency pairs with low initial investment and with the broker’s leverage.

Take note, however, that leverage increases the potential for returns but also increases the risk of losing money from your losing trades.

So, How to Profit in Forex Trading?

So, the bottom line, you want to know how to make a profit when trading foreign currencies. Let’s take an example. This will help you understand the basic rules of forex trade and avoid making trading mistakes and lose money before you start trading the real live markets.

Joey has USD$12,700 to invest in the Forex market. He decides to trade the currency pair GBP/USD which is currently trading at 1.2700 and is one of the major currency pairs (which means it has high liquidity). This means that one Pound buys 1.27 US Dollars. Joey does some research and believes the Pound will rise even more, relative to the US Dollar and so he exchanges his USD$12,700 and purchases £10,000 in a single trade.

Joey is correct in his trading assumption. The Pound strengthens against the US Dollar, and the pair is now trading at 1.3100. He now exchanges his £10,000 back into USD, except now it’s worth $13,100. As a result of his successful trading, Joey now has $13,100 in his trading account and made a profit of $400.

In the example above, Joey believed that the value of GBP would rise up against the USD, so he bought GBP/USD hoping to sell it later at a higher price.

Based on such information, would you say that Joey took a short or a long position? Don’t worry if you get it wrong, after all, you’ve only learned the terms 2 minutes ago!

Don’t worry if you get it wrong, after all, you’ve only learned the terms 2 minutes ago!

Joey made a profit from taking a long position.

In another example, what should you do if you expect the GBP to go down against the USD? You should do the opposite – sell the GBP/USD with the hope to buy it cheaper later on. This is called going short and it is how you take advantage of exchange rates that are going down.

And that’s how money is made or lost by traders in the Forex market in a nutshell. To try it yourself, we suggest you use a forex demo practice account with a financial services brokerage firm and start your forex day trading experience. Then, when you know how to open positions in the forex market, you can invest money with one of the reputable forex brokers and trade the different markets of currency pairs.

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