Buying and Selling
The basic idea of trading the markets is to buy low and sell high or sell high and buy low. I know that probably sounds a little weird to you because you are probably thinking “how can I sell something that I don’t own?” Well, in the Forex market when you sell a currency pair you are actually buying the quote currency (the second currency in the pair) and selling the base currency (the first currency in the pair).
In the case of a non-Forex example though, selling short seems a little confusing, like if you were to sell a stock or commodity. The basic idea here is that your broker lends you the stock or commodity to sell and then you must buy it back later to close the transaction. Essentially, since there is no physical delivery it is possible to sell a security with your broker since you will ‘give’ it back to them at a later date, hopefully at a lower price.
Long vs. Short
Another great thing about the Forex market is that you have more of a potential to profit in both rising and falling markets due to the fact that there is no market bias like the bullish bias of stocks. Anyone who has traded for a while knows that the fastest money is made in falling markets, so if you learn to trade both bull and bear markets you will have plenty of opportunities to profit.
LONG: When we go long it means we are buying the market and so we want the market to rise so that we can then sell back our position at a higher price than we bought for. This means we are buying the first currency in the pair and selling the second. So, if we buy the EURUSD and the euro strengthens relative to the U.S. dollar, we will be in a profitable trade.
SHORT: When we go short it means we are selling the market and so we want the market to fall so that we can then buy back our position at a lower price than we sold it for. This means we are selling the first currency in the pair and buying the second. So, if we sell the GBPUSD and the British pound weakens relative to the U.S. dollar, we will be in a profitable trade.
Now it’s time to cover order types. When you execute a trade in the Forex market it is called an ‘order’, there are different order types and they can vary between brokers. All brokers provide some basic order types, there are other ‘special’ order types that are not offered by all brokers though, and we will cover them all below:
Market Order: A market order is an order that is placed ‘at the market’ and it’s executed instantly at the best available price.
Limit Entry Order: A limit entry order is placed to either buy below the current market price or sell above the current market price. This is a bit tricky to understand at first so let me explain:
If the EURUSD is currently trading at 1.3200 and you want to go sell the market if it reaches 1.3250, you can place a limit sell order and then when / if the market touches 1.3250 it will fill you short. Thus, the limit sell order is placed ABOVE current market price. If you want to buy the EURUSD at 1.3050 and the market is trading at 1.3100, you would place your limit buy order at 1.3050 and then if the market hits that level it will fill you long. Thus the limit buy order is placed BELOW current market price.
Stop Entry Order: A stop-entry order is placed to buy above the current market price or sell below it. For example, if you want to trade long but you want to enter on a breakout of a resistance area, you would place your buy stop just above the resistance and you would get filled as price moves up into your stop entry order. The opposite holds true for a sell-stop entry if you want to sell the market.
Stop Loss Order: A stop-loss order is an order that is connected to a trade for the purpose of preventing further losses if the price moves beyond a level that you specify. The stop-loss is perhaps the most important order in Forex trading since it gives you the ability to control your risk and limit losses. This order remains in effect until the position is liquidated or you modify or cancel the stop-loss order.
Take Profit Order: An order used by currency traders specifying the exact rate or number of pips from the current price point where to close out their current position for a profit. The rate deemed to be the level where the trader wants to take a profit is sometimes referred to as the “take-profit point”.
As the name suggests, take-profit orders are used to lock in profits in the event the rate moves in a favourable direction. For example, if you are long a currency pair position and believe the price will rise to a certain level, but are unsure what it will do beyond that level, placing a take-profit order at that point will automatically close out your position allowing you to lock in profit.
Example: Buy $100 worth of yen at 107.4 yen per dollar = 100*107.40 = 10,740 yen. Place a take-profit order at 108.80. Price then rises from 107.40 to 108.80. Take-profit automatically executed to sell. The Sales Proceed is 100*188.80 = 10,880 yen. Profit of 140 yen realized.
Trailing Stop: The trailing stop-loss order is an order that is connected to a trade like the standard stop-loss, but a trailing stop-loss moves or ‘trails’ the current market price as your trade moves in your favour. You can typically set your trailing stop-loss to trail at a certain distance from current market price, it will not start moving until or unless the price moves greater than the distance you specify. For example, if you set a 50 pip trailing stop on the EURUSD, the stop will not move up until your position is in your favour by 51 pips, and then the stop will only move again if the market moves 51 pips above where your trailing stop is, so this way you can lock in profit as the market moves in your favour while still giving the trade room to grow and breath. Trailing stops are best used in strong trending markets.