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One reason why more and more speculative investors are deciding to start trading Forex is that it is possible to speculate on both rising and falling prices. While a classic investment is almost always only suitable to hope for a positive development of certain values, investors can also profit from falling prices of the corresponding currency. In the following guide we would like to inform you how to speculate on falling or rising prices and what the so-called short and long positions are.
Exchange rates can rise and fall
It is well known that currency trading works in such a way that you speculate that the value of one currency will rise or fall against another currency. As a result, Forex trading is always based on the value of two currency pairs in relation to each other, the exchange rate. For example, if we take the currency pair Euro and US dollar, the value of the dollar against the Euro can rise or fall at any time. Accordingly, the exchange rate changes, which can “run” in one direction or the other. For example, if you decide to speculate on a rising dollar exchange rate, at the same time you assume that the value of the euro will decrease against the dollar for the currency pair mentioned above. In this case, when trading in foreign exchange, you must have a buy order for the US dollar executed, which simultaneously sells Euros.
What are long positions?
Most speculative investors are also optimistic about the price trend in Forex trading and therefore choose to speculate on the rise of a currency rate. Accordingly, buy orders predominate in the market if you draw a direct comparison with sell orders in terms of volume.
Whenever you have bought a certain currency and therefore hope for a price increase, a so-called long position is formed in your trading account. Long position means that it is a real position because you have bought the currency. In the above example, this would mean that you have bought $10,000, for example, which is subsequently posted to your trading account as a position. A long position is completely independent of the currency you choose. The only important thing is that it results from the fact that you have bought a certain foreign currency. If you wish to liquidate a long position, you simply have to sell the currency in question on the foreign exchange market. You can do this by placing a sell order in the market.
What is a short position?
A short position is nothing more than the opposite of a long position. While with a long position you buy a foreign currency, the short position is formed by, for example, selling the US dollar as a foreign currency. It is important to note that you have not yet held the foreign currency in question.
Sometimes a short position is also referred to as a previous short sale, because in this case you are selling a currency that you do not have in your position. So if you think that the US dollar will lose value against the euro in the future, this is the ideal time to sell short and therefore place a sell order in the market. If this order is executed, the short position will be formed and the sold dollars will be recorded in your trading account as a negative balance. It is important to note that short positions may have to be balanced after a certain period of time, whereas long positions can usually be held for an unlimited period of time.
Different costs for short and long positions
Apart from the fact that you are speculating on rising foreign currency rates for long positions and falling rates for short positions, there is another difference. This refers to the possible costs that can arise for the respective position types. These are primarily the financing costs that Forex brokers usually charge when a position is held overnight.
It is basically irrelevant whether the position is long or short as far as the determination of the financing interest as such is concerned. In a normal interest rate phase it is usually the case that you are credited with interest for a long position, whereas you have to pay financing interest to the CFD broker for a short position. This interest is due because the broker lends you money through the leverage, which of course means a capital expense for him. As a rule, however, the financing costs are so low in relation to the traded volume that they should not influence your decision whether to buy or sell a foreign currency, i.e. whether to take a long or short position.
How do you build up a long position?
Now that you know what a long and short position is, we would like to explain briefly how a long position and a short position are built up in detail. The basic prerequisite for a long position is that you want to speculate on an increasing value of a foreign currency. In this case, an order could look as follows:
- Buy order: USD 50,000
- Exchange rate: 1.1256 dollars (per euro)
- equivalent value: 44,420 Euro
Long position over: USD 50,000
In this case, 50,000 US dollars would be booked on your trading account as a long position. As a result, you can sell either all or part of the position, thus reducing the position. The long position is reduced simply by placing a buy order in the market for the US dollar.
How does a short position build up?
To build a short position, you must sell a foreign currency that is not in your position. This is done by placing a sell order and can look like this:
- Sell order: 20,000 Swiss francs
- Exchange rate: 1.0624 francs (per euro)
- equivalent value: 18,825 Euro
- short position: 20,000 Swiss francs
To subsequently unwind or close out this short position, you must buy 20,000 Swiss francs against euros. Of course, it is also possible in this case to offset only part of the position, for example if you wish to take away any price gains already made.
Conclusion on long and short positions
As an investor, you may not even know which of your previous trading orders in Forex trading generated a long position and which generated a short position. Basically, these are mainly technical terms, because the only thing that is important for most traders is that they make price gains with forex trading. Whether a long or short position was previously traded depends solely on the trading direction. Whenever you buy a foreign currency, it is a long position, while short selling (without holding) a foreign currency leads to a short position.