Long vs Short Positions in Forex Trading November 2020

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LONG AND SHORT POSITIONS IN FOREX TRADING

Browsing through forums and websites of forex trading, you have heard of opening a long or short position at least once. In a glossary of forex-related terminologies, “going long” and “going short” on the underlying currency are important concepts that all beginners should know when they learn about forex. Keep reading this article, you will understand the fundamentals of those financial terms and learn when to use them in forex trading.

The Definition of a Position in Forex Trading

A position in forex trading is an amount of the base currency (the first currency in the pair) that is possessed by an individual and organizational trader. When investors enter a trade, the position can be either profitable or unprofitable depending on market trends and fluctuations. Only once the position is closed, a profit or loss of the trade is realized.

The position is determined by direction and size. When it comes to the direction of the position, it means whether investors would like to buy or sell the currency.

Meanwhile, the size of the position – in other words, the quantity of the underlying asset – often relies on the account equity of forex traders and the leverage ratio they choose. Most forex brokers allow traders to open a micro lot (equivalent to 10,000 units of the base currency or 0.1 lot) as the minimum trading volume, whilst some can support investors to start small with a nano lot (~100 units) if their clients do not have much experience in forex trading. Further, the position size or lot size can reach 100,000 units (a standard lot or 1 lot) if investors have a large enough trading capital.

Long and Short Positions in Forex Trading

Based on the direction of a position, it would be divided into two main types: long and short positions. Accordingly, when a forex trader expects the value of the base currency to rise in the future, he or she will go long. By contrast, going short would take place if he or she thinks its price goes down.

For instance, when you open a long position of three lots in EUR/USD, the base currency now is EUR with the position size of three lots (or 300,000 euros). The direction of the position is long because you think the pair will increase in value.

Besides, the nature of trading forex means selling the quote currency (USD) and simultaneously buying the base currency (EUR). So in the given example, when you go long on the euro, you concurrently go short on the dollar in expectation of its price falling.

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Understanding the basics of long and short positions plays an important role in forex trading. No matter whether traders choose to go long or short on the underlying currency, both positions can enable them to earn incomes if they are correct in predicting market movements based on current economic or political news and other factors.

Assume that you plan to long EUR/USD, what if the price of EUR continuously falls without any positive sign of recovering? This proves that your forecast for the upward market movement is incorrect, consequently making you sustain a loss. So when should you trade with long or short positions? The answer will be found in the two following parts.

What is a Long Position in Forex?

As already mentioned, a long position occurs when traders expect the price of the underlying currency to appreciate against the quote currency (the second currency of the pair). Simply speaking, going “long” means buying the base currency by selling the quote currency at the ask (offer) price. At this time, a trader hopes the market to increase above the entry point so that he or she will gain profits.

For example, the EUR/USD currency pair is priced at 1.18784 and 1.18814 as in the above picture. If you predict the pair’s value will go up, a long position of EUR/USD will open at 1.18814 which means the ask price. In case the market moves in your favor, your trade will be profitable. Otherwise, the long position will be closed at a pre-specified stop-loss level when the market moves against your expectation. Consequently, this act will incur an unexpected loss.

A trader’s decision of going long may be based on fundamental and technical perspectives. The fundamental analysis often looks at current economic and political situations that may impact on the currency investors would like to trade. Thereby, when the release of news or major announcements makes speculative traders think that the economy is doing beyond people’s expectations and the political system is stable, they can decide to go long.

Different from fundamental analysts, technical analysts prefer using historical data of price movements in order to predict how the price will move in the future. Accordingly, traders will attempt to look for price patterns by observing charts and indicators to see how the value previously acted.

A common buy signal for investors to open a long position appears when the price of the underlying instrument drops to a level of support or a price floor. On a chart, a level of support is an area below which the price struggles to break. That is, buying power or demand for currency is strong enough to keep the price not going down further the support level. The pair’s value then may increase again, which offers a buy signal for traders to go long.

In the chart above, the EUR/USD currency pair depreciates and is supported at the level of 1.17939 many times. In theory, the price now becomes a level of support. Hence when the price falls closely to 1.17939, forex traders may open a long position.

However, due to continuous price movements of different currency pairs, investors need to follow the market trends and adopt suitable trading strategies to adjust the support level.

What is a Short Position in Forex?

The opposite situation of long positions is short positions. Going short is a popular financial term that refers to the act of selling the base currency to buy the quote one. When a trader opens a short position, he or she expects the value of the base currency to depreciate against the quote currency in the future. Accordingly, that trader wants to sell the base currency at a bid price in the hope of a decrease in value so that he or she can buy the same currency at a lower price in the future.

For example, when you open a short position of EUR/USD at the bid price of 1.18784, you are selling euros to buy dollars. You predict that the euro value will decline. If the market goes in your favor, your trade is profitable.

Therefore, short-sellers are said to have the same purpose as long buyers when entering a trade. That is gaining profits from selling high and buying low at a later date.

Similar to long purchasers, short-sellers are also looking for sell signals from the fundamental analysis of upcoming or ongoing major events such as the US Election in 2020. When they see any negative signs from the economic situation of the currency or its country, they may choose to go short on the currency.

In the technical term, speculators normally base their “short” decision on indicators and price action. Commonly, when the price of the base currency reaches a level of resistance, it is time they open a short position. Contrary to the support level, the resistance level is an area on a chart that the price struggles to break above. Accordingly, when too many sellers would like to sell at that level, yet purchasers are less likely to buy, the supply now exceeds the demand. Therefore, the selling power will prevent the price from rising beyond the level of resistance.

As can be seen from the given chart, the price has increased to 1.18889 multiple times. The figure theoretically becomes a level of resistance, which offers traders a sell signal to short EUR/USD. Having said that, a level of resistance can be defined by various trading strategies like Moving averages, Trendline, Breakout or Range trading, and then reasonably modified.

Conclusion

Having a long or short position means forex traders are speculating on respective upward and downward movements of the market. That is, those going long or short expect a currency pair to increase or decrease in value to earn money.

Deciding when to long or short currency depends on numerous factors such as chosen trading strategies, the release of major news or indicators. Of which, a common buy or sell signal comes from levels of support and resistance separately. However, they are not the only sign for opening a long or short position, let alone the fact that in reality, it is not easy to identify proper support and resistance levels. Therefore, traders need to be equipped with deep knowledge to make wise decisions on trading forex.

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