What are you actually "buying" when you open a position on a currency pair?

Hi All!

First post, sorry for jumping straight in with a question and possibly a crazy one at that!

I am new to Forex trading and I have gotten myself very confused. I’m having trouble understanding the most fundamental thing. What actually are you buying when you ‘buy’ a currency pair? I have read quite a lot about this and I feel no one has explained fully (or even really attempted to) but I could just be stupid. Most places try to explain that you are exchanging currencies but that is definitely NOT what is happening.

I was having fun playing around with a free account but I’m a programmer and I wanted to backtest the basis of my strategy so I started writing some code. Doing the maths is when I discovered I had no idea what is actually going on.

Let me give you a concrete example and show you what I naively thought was happening:

I have an account in GBP with 1000 GBP in it.

I decide use the symbol GBP/USD which is trading at (lets pretend for simpliciy) 1.4

So I make a market order for 1000 units of GBP/USD.

IN MY MIND I have just spent 1000 GBP buying 1400 USD.

I wait till GBP/USD is trading at 1.3

Now since I have 1400 USD and the exchange rate is now 1.3, doing the maths I can buy back 1077 GBP for my 1400 USD.

So IN MY MIND I SHOULD make a market order for -1077 GBP thereby getting my original stake back with a profit of 77 GBP.

THIS IS TOTALLY WRONG.

When you actually do this you open a position by making a market order for 1000 GBP/USD. Then you close the position by making a market order of -1000 GBP/USD. If this was simply currency exchange then by making a market order of -1000 all I have done is buy back my original 1000 GBP, no profit, its the same sum, 1000 in 1000 out. So where is the profit??

So I read on babypips course and I see:

1. You are not using your balance straight away.

2. You are not buying a currency you are buying a contract of a currency pair.

So with my naive version I had an imaginal image in my head of monopoly money changing hands, now I have no image of this… contract (is it always a CFD? Does an actual currency exchange exist in the world?), I don’t know what it is I am buying and selling and if I can’t picture it then I can’t operate. I need an image.

I asked my friends who also do some forex and their response was “I don’t understand how its possible that you DON’T understand?!”

I want to understand mathematically and physically what you are actually doing when you are opening a position in the real world and what has changed hands, what thing is owned? What info is recorded in some digital ledger in some bank somewhere somehow? What I need is an image.

Sorry if this is a stupid question and many thanks for your time reading this even if you don’t respond.

As I see it you don’t own anything when you go long because you haven’t bought anything. Its just called buying because the benefits that accrue to the holder of a long position are parallel to the benefits that would accrue to someone actually owning the currency pair. But the pair is just a ratio, it cannot be owned.

To put it another way, if you go long EUR/USD using a UK broker, nobody would expect that the broker would take GBP from your account, convert it to USD and sell them in order to buy EUR, and then they would deliver those EUR to you in a box.

Private retail forex trading is betting. You bet the EUR/USD exchange rate will go up and if it does you make a profit.

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You are simply speculating on which way a number will change.

In forex. those numbers just so happen to be a currency pair’s exchange rate.

This is all explained in our lesson, What Are You Actually Trading In Forex?

@Pippo @tommor
Thanks very much for your responses. I read “What are you actually trading in forex?” and that was great, I wish the course had started with that!

I am using QuantConnect with C# and logging the my data I was getting confused. I realise now what I was seeing seems to be an aggregated notional value of my own trades which makes it kind of look like I am actually buying the currency.

Reading about A-Book and B-book makes a lot of sense now, now I can imagine what is happening I feel like I can continue.

Thanks again!

Say I am using GBP/USD and I open a 1000 unit position every minute for 100 minutes. Then at the end I have an open position of 100,000 units at the average price for the last 100 minutes (because it aggregates the notional value of each trade, so effectively I will have bought all 100,000 at the average price).

Is there any difference between doing this and if I just happened to buy 100,000 units once but at exactly the average price?

It looks to me like all the “fees” , being spread in this case, is calculated in such a way that there should be no difference between buying 1000 units 100 times thereby gradually building up my position of 100,000 OR buying 100,000 in one go. So my question is is there some penalty for building a position up gradually from multiple trades?

(should I be asking this as a separate forum topic?)

Difficult to answer because it depends on how the broker hedges.

But if you’re opening 1k positions, most likely, the broker is taking the opposite of each trade and if there are no offsets at that moment, then it aggregates it with other positions and hedging at the VWAP once its risk limit is reached.

A 100k position isn’t considered that large so you’d probably get the same pricing as a 1k position. It’s only when you start trading large sizes and partial fills start to come into play and can experience slippage to fill the rest of the order.

So you are basically saying if it is possible to place 100 trades of 0.01(1000 Units) lot size each in order to gradually complete your 1 standard lot (100,000 units) instead of placing 1 trade of 1 standard lot all at once.

If this is what you are asking then off course you can do that, I am pretty sure there won’t be any issue in this.
But just for your information, the price for your single trade of 1 standard lot (100000 units) might not be same as the price of 100 micro lot trades. While placing multiple micro lots, your trades will be placed at the best price which is available at that time in the market while placing each micro lot. And regarding commission, let say if your broker charged \$3 per standard lot, and you place 100 micro lots gradually, you will be charged 0.03 USD for each micro trade. (it may very depending upon broker to broker.)

@Pippo Thanks very much!

@ele020 Thanks for the clarification.

So I think that is in line with what I hope happens! To clarify a little further, what I mean is, I could open a position of 1 lot at 1 moment in time and get charged 1 commission unit lets say.

But say I can’t/don’t want to choose an entry moment, so instead of opening 1 lot at 1 moment in time, I open 1 lot gradually over a period of time by opening 0.01 lot every minute for 100 minutes and not closing, just gradually building the position. I am hoping that means that when I add the commission from all of those micro lots it will ultimately add up to the same as the commission on 1 lot. If so thats great.

Like you say the price, the notional value at which I purchased the lot will be different. But thats the point, so lets say GBP/USD is fluctuating wildly, in 1 hour it changes every 10 minutes:

1.3, 1.5, 1.4, 1.7, 1.6, 1.3

If I buy 1 lot at any moment I will buy 1 lot at the current price of that moment,

But if I buy 1/6th a lot every 10 minutes, then in the end I will still have 1 lot, but I will have bought it for the average price over that time because I will have bought 1/6th at 1.3, 1/6th at 1.5, 1/6th at 1.4 … etc. So the price will be the sum/6 == 1.47 ( a price that never occurred in reality).

Whether or not it would ever be a good idea to actually do this, I can’t say, but I want to explore what is possible, so what I am hoping is that if I did build up the open position gradually without closing it, there would be no penalty in terms of more commissions, than if I did it all at once?

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@Iepatus
the answer to your question depends upon the commission structure you broker is offering. If the commission structure is standard like for 1 standard lot (100K units) commission is 3 USD for both sides, then there wont be any difference in commission if you place 1 standard lot at once or place 100 micro lots over a period of time.

But if your broker charges commission based on trading volume (lets assume 3 per 100K trading volume), then the commission might vary.

When it will vary?
If you place a trade of 1 standard lot on USDCAD with EUR as your account base currency. Your commission charge will be 3 USD further converted into euros (according to the current usdeur rate) that is 2.52 Euros.
but if you place 100 lots of 0.01 you will be charged 0.03 USD for each trade but when this 0.03 is converted to Euros the total commission will vary as the conversion price of usdeur will also fluctuate in the given time span.

When the commission will not vary?
if using the above example your account base currency is USD instead of EUR then there will be no difference in commission as the exchange rate has no role here. You will be charged 3 USD commission for 1 standard lot and 0.03 commission for 0.01 lot for all 100 such trades.

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It is true that forex is all about betting on the price change of the pair, we make profits on exchange rates.