Hi all,
Firstly I would like to introduce myself. My name is Ferry, and I’m new to forex trading (Currently in babypips college). I still have some question about basic theory though…
I understand that there are two ways to make money from forex: Short-trading, and Long-trading, right?
Long-trading is when you buy a currency when it’s cheap, and sell it off when it’s high, right?
Now, the point where I was lost is the short-trading. It’s selling a currency when it’s expensive, and buy it when it’s cheap, am I correct? If so, I’m kinda confused, because how can we sell something that I don’t have?? (How can I sell USD before I even bought USD??).
My friend gave me some analogy like we’re having this one store, and we sell item A. At that particular moment, we don’t have item A, but we can sell it by saying that we actually have one, ask them to pay first, and we try to find the item to fulfill the request of item A.
Is that analogy correct?
I also have one more thing that keeps me confused. When I play long with EUR/USD for example, it means that I’m selling USD to get EUR right? I would get this USD from the ‘margin’ times my equity right? (I bought this USD using the balance in my trading account, correct?). And then, after this trade, I would have some amount of EUR right?
This is the point where I got lost… I mean, okay I do have EUR 80,000 in my pocket (trading account) right now. So what? Let’s say EUR/USD is hitting the bottom, and it would cause me to lose a lot of money, if I sell it right? So, what happened if I just leave it there? I don’t sell it until it’s getting back on its feet and touch the sky again… Can anybody explain how can I lost more money than the one that I traded previously??
I know it’s rather newbie and a longggg question. But thanks before
Clear your head of everything else and follow this.
When you trade forex you never actually take possession of any currency. Spot forex is based on a 2-day forward exchange agreement. In other words, today you agree to do the exchange in two days. You never actually get to that exchange point, though, because (assuming you carry the position overnight) your broker keeps rolling your position forward by offsetting today’s transaction (doing an opposing transaction) and opening a new one. This is call rollover and it happens at the end of each trading day. Some brokers do it very overtly, others almost transparently.
So when you go long EUR/USD you never actually exchange USD for EUR. Nothing comes out of your account and nothing goes into it aside from the gains/losses on your trades.
That all said, your profits/losses are based on the idea that you are borrowing the short currency (USD), converting it to the long one (EUR) and depositing that currency - which is where the carry comes from.
In terms of your friends example, it’s find for the stock market, but not for forex because while in stocks an exchange of possession of the stock actually takes place, that doesn’t happen in forex. Think of being long as benefiting from appreciation and short as benefiting from depreciation and you will be much better off.
And remember that in forex you are always long one thing and short the other. As in the EUR/USD example, you are long the EUR and short the USD. That means you gain by appreciation of the EUR and you gain by depreciation of the USD (relatively to each other, obviously).
Wow, thanks for the extensively enlightening reply John… It really shed some light for me.
I still have some questions though. You mentioned that the trade is 2-day forward exchange (that we agreed to do the exchange in 2 days). So what actually happens when I held my position overnight? For example, I buy EUR/USD and keep it overnight. So the broker will actually sell EUR/USD at the end of the day, and buy the EUR/USD in the next opening day?
What does it do to me if for example I bought EUR/USD and keep it open for more than 2 days? Do I lose money or something?
I’m still confused about the profit/losses though. For example, I have $500 in my account, and I buy EUR/USD (that costs me $20 for 0.1 lot using 1:500 leverage. During 1.5000 rate, it would be around $0.67 per pips right?). So after this trade, I will have $480 left in my account right? And when I sold it at 1.5010, I would get 10 pips; it’s equal to $6.7 right? After this, how much money do I have in my accounts? Is it $506.7 ($500 + 10 pips profit/$6.7) ? Or is it $486.7 ($480 + 10 pips profit/$6.7) ?
Can you also explain the short-trading using balanced-simulation like the above story?
Some brokers do a visible rollover in which you actually can see the close of your position and then a reopening of it. The result is generally the loss of the spread, since you would buy at the offer and sell at the bid. Other brokers do anything so visible (no close and re-open), but you do see carry interest charged or paid to your account.
I’m still confused about the profit/losses though. For example, I have $500 in my account, and I buy EUR/USD (that costs me $20 for 0.1 lot using 1:500 leverage. During 1.5000 rate, it would be around $0.67 per pips right?). So after this trade, I will have $480 left in my account right? And when I sold it at 1.5010, I would get 10 pips; it’s equal to $6.7 right? After this, how much money do I have in my accounts? Is it $506.7 ($500 + 10 pips profit/$6.7) ? Or is it $486.7 ($480 + 10 pips profit/$6.7) ?
You have to stop using the terms bought and sold, buy and sell. As I noted before, you never take possession of anything. You don’t actually buy. You go long, or you go short. You exit a long or you exit a short. The margin you put up for a EUR/USD is not something you pay. It isn’t a cost. It’s just funds set aside to cover the broker in case you take an oversized loss. Your profits and losses are added to/subtracted from you overall balance.
And your math is off. A pip on a mini lot (0.1) is $1 for EUR/USD.
Hi John, sorry for the ‘very’ late reply. Again, thanks for your reply, it’s very enlightening. I kinda get the system now…
And yes you’re right, I was mistaken in my calculation, I didn’t notice the base currency, lol
