Buying and Selling Simultaneously
The biggest mental hurdle facing newcomers to currencies, especially traders familiar with other markets, is getting their head around the idea that each currency trade consists of a simultaneous purchase and sale. In the stock market, for instance, if you buy 100 shares of Google, you own 100 shares and hope to see the price go up. When you want to exit that position, you simply sell what you bought earlier. Easy, right?
But in currencies, the purchase of one currency involves the simultaneous sale of another currency. This is the exchange in foreign exchange. To put it another way, if you’re looking for the dollar to go higher, the question is “Higher against what?”
The answer is another currency. In relative terms, if the dollar goes up against another currency, that other currency also has gone down against the dollar. To think of it in stock market terms, when you buy a stock, you’re selling cash, and when you sell a stock, you’re buying cash.
Currencies come in pairs
To make matters easier, forex markets refer to trading currencies by pairs, with names that combine the two different currencies being traded, or “exchanged,” against each other. Additionally, forex markets have given most currency pairs nicknames or abbreviations, which reference the pair and not necessarily the individual currencies involved.
Major currency pairs
The major currency pairs all involve the U.S. dollar on one side of the deal. The designations of the major currencies are expressed using International Standardization Organization (ISO) codes for each currency. Table 2-1 lists the most frequently traded currency pairs, what they’re called in conventional terms, and what nicknames the market has given them.
Major cross-currency pairs
Although the vast majority of currency trading takes place in the dollar pairs, cross-currency pairs serve as an alternative to always trading the U.S. dollar. A cross-currency pair, or cross or crosses for short, is any currency pair that does not include the U.S. dollar. Cross rates are derived from the respective USD pairs but are quoted independently.
Crosses enable traders to more directly target trades to specific individual currencies to take advantage of news or events. For example, your analysis may suggest that the Japanese yen has the worst prospects of all the major currencies going forward, based on interest rates or the economic outlook. To take advantage of this, you’d be looking to sell JPY, but against which other currency? You consider the USD, potentially
buying USD/JPY (buying USD/selling JPY) but then you conclude that the USD’s prospects are not much better than the JPY’s. Further research on your part may point to another currency that has a much better outlook (such as high or rising interest rates or signs of a strengthening economy), say the Australian dollar (AUD). In this example, you would then be looking to buy the AUD/JPY cross (buying AUD/selling JPY) to
target your view that AUD has the best prospects among major currencies and the JPY the worst.
The most actively traded crosses focus on the three major non- USD currencies (namely EUR, JPY, and GBP) and are referred to as euro crosses, yen crosses, and sterling crosses.
The long and the short of it
Forex markets use the same terms to express market positioning as most other financial markets. But because currency trading involves simultaneous buying and selling, being clear on the terms helps — especially if you’re totally new to financial market trading.
Going long
No, we’re not talking about running out deep for a football pass. A long position, or simply a long, refers to a market position in which you’ve bought a security. In FX, it refers to having bought a currency pair. When you’re long, you’re looking for prices to move higher, so you can sell at a higher price than where you bought. When you want to close a long position, you have to sell what you bought. If you’re buying at multiple price levels, you’re adding to longs and getting longer.
Getting short
A short position, or simply a short, refers to a market position in which you’ve sold a security that you never owned. In the stock market, selling a stock short requires borrowing the stock (and paying a fee to the lending brokerage) so you can sell it. In forex markets, it means you’ve sold a currency pair, meaning you’ve
sold the base currency and bought the counter currency. So you’re still making an exchange, just in the opposite order and according to currency-pair quoting terms. When you’ve sold a currency pair, it’s called going short or getting short and it means you’re looking for the pair’s price to move lower so you can buy it back at a profit. If you sell at various price levels, you’re adding to shorts and getting shorter.
In currency trading, going short is as common as going long. “Selling high and buying low” is a standard currency trading strategy.
Currency pair rates reflect relative values between two currencies and not an absolute price of a single stock or commodity. Because currencies can fall or rise relative to each other, both in medium and long-term trends and minute-tominute fluctuations, currency pair prices are as likely to be going down at any moment as they are up. To take advantage of such moves, forex traders routinely use short positions to exploit falling currency prices. Traders from other markets may feel uncomfortable with short selling, but it’s just something you have to get your head around.
Squaring up
Having no position in the market is called being square or flat. If you have an open position and you want to close it, it’s called squaring up. If you’re short, you need to buy to square up. If you’re long, you need to sell to go flat. The only time you have no market exposure or financial risk is when you’re square.
Source: The Mechanics of Currency Trading
