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The Mechanics of Currency Trading-1

trading systemWelcome Back! Ready for your next lesson in Forex Trading! This portion of the training will also be in 2 parts.

The currency market follows a particular lingo and conventions, just like any financial market. If one is new to currency trading terminologies, it may take some time getting used to it. But at the end of the day, it’s all about buying and selling.

Buying and Selling Simultaneously

Each currency trading transaction consists of a simultaneous purchase and sale. In the stock market, for instance, if you buy 500 shares of Microsoft, 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. However, in currencies, the purchase of one currency involves the simultaneous sale of another currency. For e.g. if you’re looking for the dollar to go higher, the question is “Higher against what?”

In relative terms, if the dollar goes up against another currency, that other currency also has gone down against the dollar.

Currencies Come in Pairs

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.

ISO Currency Pair Countries Long Name Nickname
EUR/USD Euro zone*/U.S. Euro-dollar N/A
USD/JPY U.S./Japan Dollar-yen N/A
GBP/USD United Kingdom/U.S. Sterling-dollar Sterlingor Cable
USD/CHF U.S./Switzerland Dollar-Swiss Swissy
USD/CAD U.S./Canada Dollar-Canada Loonie
AUD/USD Australia/U.S Australian-dollar Aussie or Oz
NZD/USD New Zealand/U.S. New Zealand-dollar Kiwi

* The Euro zone is made up of all the countries in the European Union that have adopted the euro as their currency.

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Major Cross-Currency Pairs

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

Table 2-2 highlights the most actively traded cross currency pairs.

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

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 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-to-minute 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.

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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.

Profit and Loss

Profit and loss (P&L) is how traders measure success and failure. A clear understanding of how P&L works is especially critical to online margin trading, where your P&L directly affects the amount of margin you have to work with. Changes in your margin balance determine how much you can trade and for how long you can trade if prices move against you.

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