What Does It Mean to “Go Long” in Forex?

What Does It Mean to “Go Long” in Forex?

When you are trading foreign currency and go “long” in a currency, you are simply placing a buy order on a currency pair. In foreign currency (forex) trading, all currency pairs have a base currency and a quote currency. The quote usually looks something like this: USD/JPY = 100.00. The USD is the base currency and the JPY is the quote currency.

Reading a Quote
This quote shows a rate of $1 US Dollar being equal to 100 Japanese Yen. When you place a long trade on this currency pair, you are going long on the USD Dollar and you’ll simultaneously go short on the Japanese Yen, which means you’re effectively selling the yen, just like when you short a stock by selling shares.

It may sound complicated, but you would make this trade if you believed that $1 was going to become more valuable than 100.00 Japanese Yen, meaning that $1USD = 101.00JPY.

Trend-following traders who watch trend acceleration often go long on a trade position and hope to stay in that trade until the trend expires.

Why Go Long in Forex?
Some of the reasons that traders go long come from technical and fundamental developments. From a fundamental perspective, economic news releases can start to overshoot or surprise economists’ expectations.

This shows that the economy is doing better than many people expected and there’s room for upside on that currency, and therefore, it may be worth buying the currency or going long.

Another fundamental reason that forex traders may decide to go long a currency pair is when a central bank announces its plans for monetary tightening, which historically tends to lift its currency’s value.

Technical reasons for going long often include currency prices breaking through a certain price-level resistance or a price ceiling. This would show surprising strength in the currency’s price mobility and that a new market imbalance may be developing that could turn into a strong trend. Traders also tend to go long when the currency price comes down to a well-defined support level or a price floor.

What New Traders Should Know
It is important for new Forex traders to understand that any time you are in a currency trade, you are always long one currency of the pair. Even if you were short the pair, you are technically short the base currency, which is the first currency in the pair, and long the price for the counter currency.

To borrow an example from another market, when you buy the stock of a company like Apple (NASDAQ: AAPL), you are going long in Apple stock and short the US dollar because you feel the value of a dollar will not grow as fast as the value of Apple stock.

You could also look at this relationship as APPL/USD. Also, when you sell your stock back, you can think of it as going long in the US dollar, and short on the stock because for one reason or another you now believe it is more valuable to have cash in dollars​ than it is to hold the stock.

The Difference Between Forex and Commodity Trading

The difference between forex trading and commodity trading is quite simple. A commodity market is a market that trades in manufactured goods such as coffee and cocoa (or mined products such as gold and oil). Forex (the foreign exchange market) is a global market that trades in currencies (such as dollars). Which market you prefer has a lot to do with your comfort level with the following factors.

Personal Choice
Some people feel more comfortable with certain types of markets. Some people like commodities because it’s a physical market they can relate to. Because many commodities can be seen in everyday life, some traders prefer commodities because they can connect to things like sugar cane and wheat.

Differences in Regulation
The commodities markets are very regulated, while forex is more like the wild west. There is some regulation with forex, but it’s a lot looser. There is a fair amount of circumvention of What little regulation exists already. And some traders feel they are better off with the government on their side.

Leverage
Although there is leverage in both markets, there is a significant amount of leverage in the forex market and you don’t have to jump through hoops to have it. All you do is fund your account with a few hundred dollars and you can control thousands. While leverage is also an option in commodities markets, the leverage in forex trading is much more spectacular.

Exchange Limits
Commodities trade on an exchange whereas foreign exchanges are over-the-counter and traded through brokers or in the interbank market. By trading on an exchange, commodities have daily range limits. When these limits are exceeded, the markets are said to be limit up or limit down, and no trades can be placed. If you are a commodity trader on the wrong side of one of these limit moves, you basically are watching your account dissipate without the ability to act.

While quick losses can also happen in the FX market, there are very few instances where you are absolutely unable to exit your trade which can happen with exchange limits and commodity markets.

Compromise
A trader looking for a compromise could trade commodity-based currencies. These currencies include the Australian dollar, the Canadian dollar, and the New Zealand dollar. Historically, the Australian dollar has a positive correlation to the price of Spot Gold (although the strength of the correlation varies over time). The dairy reliant New Zealand economy has a similar positive correlation with whole milk powder prices. Lastly, the Canadian dollar has a positive correlation with the price of crude oil.

Therefore, with the strong trends in oil in 2014 through 2016, the Canadian dollar has similarly seen strong moves.

Another subset of the foreign exchange market is that of emerging market currencies. Emerging market currencies also reflect commodity growth and tend to have an inverse correlation with the US dollar. Commodity currencies also pay higher rollover then developed market currencies. Therefore, in the right market, emerging market currencies can make a nice complement to the volatility seen in commodity trading.

The Meaning of Drawdown in Forex

Drawdown is the difference between the balance of your account and the net balance of your account. The net balance factors in open trades that are currency in profit or in a loss.

When your account net balance is lower than your account balance, you have what is known as a drawdown. As an example, let’s say that a currency trading system begins with a balance of $100,000. It then sees an equity drop down to $95,000. It has a $5,000 drawdown.

What You Can Learn From a Drawdown
Drawdowns also describe the likely survivability of your system over the long run. A large drawdown puts an investor in an untenable position.

Consider this: A client who endures a 50-percent drawdown has a large task and a real challenge ahead of him because he must have a 100-percent return on the reduced capital stake just to break even on the reduced equity position.

Many investors or fund managers on Wall Street are ecstatic with around 20 percent for the year. As you can imagine, a trader who suffers a drawdown is best served to simply readjust his system as opposed to trying to aggressively trade his way back to the breakeven point.

Typically, an aggressive approach to get his capital back to break even will have the opposite result. Why? He will most likely use leverage and over-trade to get his trading account back to even.

Too Much Leverage
When traders use too much leverage, one bad trade can have disastrous effects—and it often does. In short, traders are either too aggressive or too confident, and this leads to sharp losses or an unwillingness to accept a trade as a loser that should be cut. There is an old adage in trading that one trade will rarely make your trading career, but one bad trade can certainly end your career.

Recommended Reading
What I Learned Losing $1,000,000 by Jim Paul and Brian Moynihan offers some excellent insight if you’d like to read a book that describes the emotional toll of taking a drawdown.

The book discusses how a trader lost his career, significant amounts of his family’s fortune, as well as money of his friends by taking a large drawdown.

This book also shares some excellent tips on how to overcome this common pitfall of trading without implementing a plan that is likely to be emotionally driven.

The Takeaway
One of the greatest tips is to have a predetermined stop-loss point on your trade before entering. This will limit the amount of any drawdown you will take.

You’ll be able to stand back after you’ve entered the trade, knowing that you’re out of it with no questions asked when and if the level is hit.

A lot of traders make the mistake of trying to negotiate with the market as to whether they should stay in the trade.

It’s a mistake because you’ll be emotionally driven and likely to do the thing that is the least painful at the time but not necessarily more beneficial down the road.

A forex broker works as an intermediary between you and the interbank system. If you don’t know what the interbank is, it’s a term that refers to networks of banks that trade with each other.

Typically a Forex broker will offer you a price from the banks of which they have lines of credit and access to forex liquidity. Many forex brokers use multiple banks for pricing, and they’ll offer you the best one available.

Opening a Forex Trading Account
To get an account with a forex broker, it’s a bit like opening a bank account. It requires paperwork and steps such as identity verification. The whole process takes a few days.

However, if you’re just looking to test the waters, forex brokers offer demo accounts for which you only need to provide minimal information to open. A demo or practice account allows you to get set up and get some practice trading until you’re ready to get started trading with real money.

Forex Brokers Offer You Leverage
The ability to use forex leverage comes with every account, and it varies in an amount anywhere from 10:1 to 100:1. A 10:1 leverage means that for every $1 in your account, you have $10 to trade.

Leverage is both good and bad as you can make exponential profits, but you can also suffer from mounting losses. The law requires forex brokers to disclose this, and they typically do in fine print. New traders usually get excited and blow their accounts out quickly if they jump in too fast.

You’ll Have Two Balances
When you’re working and trading with a forex broker, there are two balances shown for your account. One balance is your actual balance, not including your open trades. Your other balance is the balance that you would have if you closed all your trades. The second balance is called your net balance.

The Bid-Ask Spread
When you open a forex trade with a broker, they pass it through to the market for you. In the process of this, they offer you a price for the currency pair that is slightly different than the price they can get.

You’ll see it shown in quote form as EUR/USD 1.3600/1.3605, for example, where the first number is what the broker will give you if you want to sell the currency pair, and the second number shows what the broker will charge if you want to buy the pair. The difference of .0005, or 5 pips, is the broker’s commission. The spread may widen or narrow depending on trading supply and demand.

The bid/ask difference charge is called collecting the spread. The spread or commission of sorts is mostly transparent to trading from the trader’s point of view. However, you always have to keep in mind that the beauty of the spread from the broker’s point of view is that it’s taken from your leveraged trade size, not your account balance size.

Education to Learn Forex Trading
Forex is a relatively new arena for many investors. News that affects a stock price may have a radically different effect on the price of a currency. Also, learning how to price currencies and invest in them in a relative environment is often uncomfortable territory when a prospective investor first comes into forex.

To battle the lack of knowledge that many have due to the uniqueness of the forex market, many brokers have set up divisions dedicated to education and research to help traders get up to speed and informed on a day-to-day basis. A popular destination for many traders is the website DailyFX.

Verifying a Broker’s Reputation
Forex brokers exist to make it easier for you to connect with the banks out there that are buying and selling currencies. They have a set of rules that they have to follow and certain processes that are required.

However, for many years, the forex industry was not regulated, and although it’s improved dramatically, you may still run into some forex brokerages that are less-than-reputable. The National Futures Association (NFA.futures.org) follows forex brokers and can help you verify a broker’s reputation.

When choosing a broker to work with, check first to see if they’re regulated by a U.S. authority. Regulated brokers will disclose this information on their website.